Individual retirement accounts have been steadily growing over the years, causing potential tax issues for retirees and their beneficiaries. According to the Employee Benefit Research Institute, the median IRA or self-employed Keogh balance has increased to $87,000 in 2022, up from $81,144 in 2019. Additionally, a report from Fidelity found that the average IRA balance was $127,745 during the first quarter of 2024, which represents a 29% increase from 2014.
While the growth of IRA balances may seem like a positive development, it can actually lead to a tax nightmare for retirees. Derek Williams, a certified financial planner, warns that a larger pretax IRA balance can result in significant tax implications during retirement. Withdrawals from traditional IRAs incur regular income taxes, depending on the individual’s tax bracket. As pretax balances continue to grow, retirees may face larger required minimum distributions, which can trigger tax consequences such as higher Medicare premiums.
In addition to retirees, beneficiaries of larger IRAs can also face tax issues. Recent changes to tax law have made pretax IRAs less desirable assets to inherit. Prior to the Secure Act of 2019, heirs could stretch IRA withdrawals over their lifetime, reducing yearly taxes. However, under the new law, most adult children and other heirs have a 10-year window to empty inherited IRAs. This change can be particularly burdensome for beneficiaries who may be in their highest earning years when they inherit the account, leading to significant tax liabilities.
To address the tax implications of larger IRA balances, financial advisors recommend various strategies. One option is to consider Roth conversions, which involve transferring pretax or nondeductible IRA funds to a Roth IRA. While there is an upfront tax on the converted balance, this strategy can be beneficial during lower-income years. By converting to a Roth IRA, individuals can potentially reduce their future tax burden and avoid some of the negative tax consequences associated with traditional IRAs.
Legislation such as Secure 2.0 has introduced changes to required minimum distributions, requiring most retirees to begin withdrawing funds from their IRAs by age 73, with an extension to age 75 in 2033. While these changes aim to address the issue of growing IRA balances, they also present challenges for retirees and beneficiaries. Financial planning strategies, such as Roth conversions, can help individuals navigate the complex tax implications of larger retirement accounts and ensure a more secure financial future.
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