Roth IRA Conversion 2011 for Young Beneficiary

Do you do a Roth IRA Conversion in 2011 or not? That's your question. One circumstance whenever conversion makes sense is when you're bequeathing it all to a young IRA beneficiary. Lets look at the Roth IRA conversion for 2011 and see why.

First, recall the features of traditional IRAs. Any withdrawals from them are taxed as ordinary income since they were funded with tax deductible contributions and grew tax-deferred. There is also the required IRA minimum distributions (RMDs) commencing at age 70½ which deplete traditional IRAs and increase your income tax.

On the other hand, a Roth IRA does not have minimum distribution requirements for the owner or his spouse and distributions are not taxable. For this reason, a Roth IRA conversion in 2011 looks attractive.

A Roth IRA conversion for 2011 will necessitate the payment of ordinary income tax on the traditional IRA converted. Note that a Roth conversion makes little sense under these scenarios:

you expect your income tax rate to be noticeably lower later when you anticipate Roth IRA withdrawals
you expect to withdrawal a significant portion of the Roth IRA within 5 years
you must use any of the IRA funds to pay the conversion tax

Note that even if you expect your income to be lower during retirement, your tax rate may not be lower if the US government increases rates for all.

Having a young IRA beneficiary makes the Roth IRA Conversion 2011 more compelling.

First, because a Roth has no RMDs, it is a tax shelter that won't deplete as you become older. Therefore, the account balance can grow as long as you desire (or live). Second, even though non-spouse beneficiaries will be forced to make annual withdrawals form the Roth IRA, a young age will make those withdrawals very small (see tables for beneficiaries in the appendix of IRS Publication 590). For example, the required withdrawal for a 20-year-old beneficiary is 1.6% of the IRA balance. If the IRA earns 6%, it's clear that the account will continue to grow in value, completely tax free.

So a young inheritor will have very low RMDs - merely a percent or two of your account - for many years. Had the beneficiary inherited a traditional IRA and taken his mandatory withdrawals, the withdrawal would be added on top of his income from his job and taxed at a significant rate. Therefore, a Roth IRA Conversion in 2011 provides tens of thousands of additional dollars to a young beneficiary.

Now if the young beneficiary does not exhaust the Roth IRA, it passes to his beneficiary who will also enjoy tax free growth and income. You Roth IRA conversion 2011 has many benefits including the potential to benefit yourself and two additional generations.