Getting money into a Roth IRA is simple: You can either make direct contributions to the account, or you can roll over or convert funds from other types of retirement accounts into a Roth IRA. With income limits restricting the ability of higher-income retirement savers from making direct Roth contributions, conversions and rollovers have become more popular. Moving money into a Roth IRA avoids any possibility of penalties for early withdrawal from the retirement account framework, but depending on the source of retirement funds, putting money into a Roth IRA can have other tax consequences, including higher income tax bills. By knowing what funding sources are eligible for a Roth conversion or rollover, you'll be better prepared for the impact of moving money into a Roth.
Roth rollovers with no tax consequences
First, there are some rollovers to Roth IRAs that don't have any tax consequences. The simplest is moving money from one Roth IRA to another. Such a rollover doesn't lead to taxes or penalties as long as it's done correctly. Only if the rollover isn't completed in a timely manner is there a risk of tax consequences.
In addition, if you have access to a Roth 401(k) account at work, then rolling over that money into a Roth IRA also avoids any tax consequences. The tax-free nature of the Roth assets is preserved, and you have the full range of investment alternatives that your Roth IRA offers.
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Roth conversions from traditional IRAs
If you have money in a traditional IRA, there's no longer any income restriction on your ability to convert it to a Roth IRA. However, there are tax consequences for doing so. To the extent that your IRA has money that came from deductible contributions or earnings within the account, you'll have to include the amount you convert in taxable income.
One thing to keep in mind, though, is that if you made nondeductible contributions to your traditional IRA, then you'll be entitled to claim a pro rata share of those contributions to reduce the amount of taxable income you report. For instance, if you made a nondeductible contribution of $1,000 and you convert half of your total IRA assets of $10,000 to a Roth IRA, then you'll have taxable income of $4,500 -- half of the $10,000, or $5,000, minus half of the nondeductible $1,000 contribution amount, or $500.
Rollovers from traditional 401(k) and other retirement plans to Roth IRAs
For a long time, rollovers from 401(k) plans or other employer-sponsored retirement accounts directly to a Roth IRA weren't allowed. You first had to roll over employer retirement money to a regular IRA, and then convert the regular IRA to a Roth IRA. Now, however, the government has recognized the fact that that extra step shouldn't be necessary, and so they've allowed direct rollovers from traditional 401(k)s to Roth IRAs.
The tax consequences for such a move are the same as for a traditional IRA to Roth IRA conversion. You'll have to treat pre-tax contributions as taxable income in the year in which you convert to the Roth IRA, but any after-tax contributions aren't required to be included in taxable income.
What you can't roll over to a Roth IRA: An Inherited IRA
Finally, there's one category of retirement account that's not eligible for moving to a Roth IRA: an inherited traditional IRA. If you inherit a traditional IRA, you're stuck with the traditional nature of that retirement account under current law. The only exception is if you're the spouse of the deceased IRA holder, you have the right to move inherited IRA assets into your own IRA. From there, you can then convert your own IRA to a Roth. However, non-spouse beneficiaries don't have that option.
Roth IRAs can be useful, and funding them is easier than you might think. With so many different potential sources of funds, you could be able to start and build up your Roth IRA faster than you expected.