Individual retirement accounts are getting bigger — and it can cause tax issues for retirees or their children who inherit the assets, experts say.
The median IRA or self-employed Keogh balance was $87,000 in 2022, up from $81,144 in 2019, according to a June report from the Employee Benefit Research Institute, which analyzed Federal Reserve data.
A separate Fidelity report found the average IRA balance was $127,745 during the first quarter of 2024, up 29% from 2014, based on an analysis of 45 million IRA, 401(k) and 403(b) accounts.
While higher balances are typically a good thing, a bigger pre-tax IRA balance “can be a tax nightmare in retirement,” said certified financial planner Derek Williams with Veratis Advisors in Cary, North Carolina.
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The Employee Benefit Research Institute report found that more than 45% of IRA assets were in rollover IRAs, which are typically funded via past employer plans. Only about 17% of analyzed assets were in Roth IRAs, which don’t incur taxes on withdrawals.
Required minimum distributions can cause tax issues
While certain investors can get an upfront deduction on traditional IRA contributions, withdrawals in retirement incur regular income taxes, depending on your tax bracket. Investors can typically start taking IRA withdrawals without penalty starting at age 59½.
As pretax balances grow, retirees can expect larger required minimum distributions, which can trigger tax consequences like higher premiums for Medicare Part B and Part D, Williams said.
Starting in 2023, most retirees need to begin required minimum distributions, or RMDs, by age 73, based on changes enacted by Secure 2.0. That age is extended to 75 starting in 2033.
“Congress isn’t really helping people out,” said CFP Sean Lovison, founder of Philadelphia-area Purpose Built Financial Services.
By postponing required withdrawals, pretax balances will continue to grow, which can lead to larger RMDs later, he said.
For lower future taxes, some advisors recommend so-called Roth conversions, which transfer pretax or nondeductible IRA money to a Roth IRA. The strategy can be useful during lower-income years because there’s an upfront tax on the converted balance.
Pretax IRAs are ‘much less desirable’ to inherit
Bigger IRA balances could also cause tax issues for adult children who inherit their parents’ accounts, experts say.
“Recent changes to tax law have made pretax IRAs a much less desirable asset to inherit,” said Williams with Veratis Advisors.
Before the Secure Act of 2019, heirs could stretch IRA withdrawals over their lifetime, which reduced yearly taxes. Now, certain heirs, including most adult children, have a 10-year window to empty inherited IRAs.
The death of a parent often coincides with an heir’s highest earning years and taxes could “eat away a tremendous amount of an inherited pretax account,” Williams said.