As reported by experts, individual retirement accounts (IRAs) and self-employed Keogh accounts have been steadily growing over the years. The median IRA balance in 2022 was $87,000, showing an increase from $81,144 in 2019. Additionally, a Fidelity report found that the average IRA balance during the first quarter of 2024 was $127,745, which is up by 29% from 2014. While the growth of these retirement accounts may seem positive, it can potentially lead to tax issues for retirees or their heirs in the future.
Certified financial planner Derek Williams from Veratis Advisors in Cary, North Carolina, warns that a bigger pretax IRA balance can become a “tax nightmare in retirement.” With higher balances, retirees may face challenges such as increased required minimum distributions (RMDs) that could trigger tax consequences like higher Medicare Part B and Part D premiums. As pretax balances continue to grow, retirees need to be aware of the potential tax implications that come with it.
Starting in 2023, most retirees are required to begin taking RMDs by age 73, based on changes made by Secure 2.0. This age requirement is then extended to 75 starting in 2033. However, by postponing these required withdrawals, pretax balances will continue to increase, resulting in larger RMDs in the future. Financial experts, including CFP Sean Lovison, suggest considering Roth conversions to potentially lower future taxes. This strategy involves transferring pretax or nondeductible IRA funds to a Roth IRA, especially during lower-income years to minimize tax implications.
In addition to retirees, adult children who inherit their parents’ IRA accounts may also face tax challenges due to the growing account balances. Recent changes to tax laws have made pretax IRAs less desirable assets to inherit. Before 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 heirs have a 10-year window to empty inherited IRAs, potentially leading to higher tax burdens. The timing of inheriting an IRA during an heir’s highest earning years could result in significant tax implications that eat away a considerable portion of the inherited pretax account.
The increasing size of individual retirement accounts can create tax complexities for both retirees and their heirs. It is crucial for individuals with larger IRA balances to understand the potential tax consequences, plan for required minimum distributions, and consider strategies like Roth conversions to mitigate future tax liabilities. Additionally, heirs of IRAs should be aware of the changing tax laws and implications of inheriting pretax accounts to make informed decisions regarding their inherited assets.