In recent years, individual retirement accounts (IRAs) have been increasing in size, which has led to potential tax issues for retirees and their heirs. According to the Employee Benefit Research Institute, the median IRA or self-employed Keogh balance was $87,000 in 2022, showing a steady increase from $81,144 in 2019. Additionally, a Fidelity report found that the average IRA balance was $127,745 in the first quarter of 2024, marking a 29% increase from 2014. While having larger balances in retirement accounts is generally seen as a positive development, it can create complexities when it comes to tax obligations.
Certified financial planner Derek Williams warned that a bigger pretax IRA balance can lead to a tax nightmare for retirees. Withdrawals from traditional IRAs are subject to regular income taxes, depending on the individual’s tax bracket. As pretax balances grow, retirees may face larger required minimum distributions, which come with their own set of tax consequences, such as higher premiums for Medicare Part B and Part D. The current rules state that most retirees must start taking required minimum distributions by age 73 starting in 2023 and age 75 starting in 2033.
To mitigate potential tax issues in retirement, some financial advisors recommend Roth conversions. This strategy involves transferring pretax or nondeductible IRA funds into a Roth IRA, which incurs an upfront tax but can lead to lower taxes in the future. By converting to a Roth IRA during lower-income years, retirees can potentially reduce their tax burden in retirement and avoid significant tax consequences associated with larger IRA balances.
In addition to retirees, adult children who inherit their parents’ IRAs may also face tax challenges due to the changes in tax laws. Previously, heirs could stretch IRA withdrawals over their lifetime, resulting in lower yearly taxes. However, under the Secure Act of 2019, most adult children now have a 10-year window to empty inherited IRAs, which can lead to significant tax implications. With the death of a parent often coinciding with an heir’s peak earning years, the taxes associated with inherited pretax accounts can erode a substantial portion of the assets.
The increasing size of individual retirement accounts has raised concerns about tax issues for both retirees and their heirs. As IRA balances grow, retirees may encounter higher tax obligations in retirement, leading to potential financial challenges. By proactively addressing these tax issues through strategies like Roth conversions and careful estate planning, individuals can better prepare for the tax implications of larger retirement account balances.
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