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Individual retirement accounts are growing in size, and that could pose tax problems for retirees or their children who inherit the assets, experts say.
The median IRA or self-employed Keogh balance was $87,000 in 2022up 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 that average IRA balance reached $127,745 in 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 positive, a larger pre-tax balance in an IRA “can be a tax nightmare during retirement,” says certified financial planner Derek Williams of 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 through previous employer plans. Only about 17% of the assets analyzed were in Roth IRAs, which are not taxed on withdrawals.
Mandatory minimum distributions can cause tax problems
From 2023, most retirees will have to start required minimum distributions, or RMDs, at age 73, under changes implemented by Secure 2.0. That age will be extended to 75 starting in 2033.
“Congress isn't really helping people,” said CFP Sean Lovison, founder of Purpose Built Financial Services in the Philadelphia metro area.
By delaying required withdrawals, pre-tax balances will continue to grow, which could lead to higher RMDs later, he said.
To lower future taxes, some advisors recommend Roth conversions, in which tax-free or nondeductible IRA money is rolled over to a Roth IRA. The strategy can be useful during lower-income years because there is a prepayment tax on the converted balance.
Pretax IRAs are 'much less desirable' to inherit
Higher IRA balances can also create tax problems for adult children who inherit their parents' accounts, experts say.
“Recent changes in the tax law have made tax-free IRAs a much less attractive heir option,” said Williams of Veratis Advisors.
The death of a parent often coincides with an heir's highest earning years, and taxes can “eat up a huge chunk of the inherited net profit margin,” Williams said.
