The growth of individual retirement accounts has been on the rise in recent years. According to a report from the Employee Benefit Research Institute, the median IRA balance was $87,000 in 2022, up from $81,144 in 2019. This increase in balances can potentially cause tax issues for retirees and their children who inherit the assets. While higher balances are usually viewed as a positive thing, having a larger pretax IRA balance in retirement can be a tax nightmare, as noted by certified financial planner Derek Williams.
As pretax balances in IRAs grow, retirees can expect larger required minimum distributions (RMDs). These RMDs can trigger tax consequences such as higher premiums for Medicare Part B and Part D, according to Williams. Starting in 2023, most retirees are required to begin taking RMDs by age 73, which is extended to 75 starting in 2033. The postponement of required withdrawals by Congress only allows pretax balances to continue to grow, leading to even larger RMDs later on.
To potentially lower future taxes, financial advisors suggest considering Roth conversions. This strategy involves transferring pretax or nondeductible IRA money to a Roth IRA. While there is an upfront tax on the converted balance, it can be beneficial during lower-income years. By converting to a Roth IRA, retirees can avoid the tax consequences of growing pretax IRA balances.
The increase in IRA balances could also have tax implications for adult children who inherit their parents’ accounts. Recent changes in tax laws have made pretax IRAs a less desirable asset to inherit. Before the Secure Act of 2019, heirs could stretch IRA withdrawals over their lifetime, reducing yearly taxes. Now, most adult children and other heirs have a 10-year window to empty inherited IRAs. This could result in significant tax implications, especially if the inheritance coincides with the heir’s highest earning years.
The growth of individual retirement account balances can potentially lead to tax issues for retirees and their heirs. It is essential for individuals to carefully consider the tax implications of growing pretax balances in retirement and explore strategies such as Roth conversions to mitigate future tax burdens. Additionally, heirs should be aware of the changing tax laws surrounding inherited IRAs and plan accordingly to minimize tax consequences. By staying informed and proactive about tax planning, individuals can navigate the complexities of growing IRA balances in retirement.