Individual retirement account balances are growing — why that can be a ‘tax nightmare,’ advisor says

Individual retirement accounts (IRAs) are growing in size, potentially leading to tax issues for retirees and their heirs. According to a June report from the Employee Benefit Research Institute, the median IRA or self-employed Keogh balance increased from $81,144 in 2019 to $87,000 in 2022. A separate report by Fidelity found the average IRA balance was $127,745 in the first quarter of 2024, marking a 29% increase since 2014. Despite the positive growth, certified financial planner Derek Williams from Veratis Advisors warns that larger pretax IRA balances can be problematic, as over 45% of IRA assets are in rollover IRAs, which incur taxes on withdrawals, while only about 17% are in Roth IRAs, which are tax-free on withdrawal.

Higher IRA balances necessitate larger required minimum distributions (RMDs), which can lead to significant tax consequences. Traditional IRA contributions offer upfront tax deductions, but withdrawals are taxed as regular income during retirement. This can affect retirees’ tax brackets and potentially increase premiums for Medicare Part B and Part D. With the Secure 2.0 Act, retirees must begin taking RMDs at age 73 starting in 2023, extending to age 75 by 2033. Delaying RMDs results in continued growth of pretax balances, leading to larger future withdrawals and higher taxes. Financial advisors recommend Roth conversions, transferring pretax IRA money to Roth IRAs during lower-income years to manage future tax liabilities.

The tax implications of larger IRAs extend to heirs as well. The Secure Act of 2019 changed the rules for inherited IRAs, requiring most adult children to deplete these accounts within ten years, as opposed to stretching withdrawals over their lifetime. This change can result in substantial tax burdens, particularly if the inheritance coincides with the heirs’ peak earning years. Derek Williams highlights that these changes make pretax IRAs less desirable for inheritance, as the taxes could significantly reduce the value of the inherited accounts. Financial planning to manage IRA balances and consider tax-efficient strategies like Roth conversions is essential for mitigating these issues.

For more information see Kate Dore “Individual retirement account balances are growing — why that can be a ‘tax nightmare,’ advisor says“, CNBC, July 2, 2024.

Special thanks to David S. Luber (Florida Probate Attorney) for bringing this article to my attention.