A large traditional IRA can be a wonderful retirement asset. But it can also become a future tax problem hiding in plain sight.
That is because once required minimum distributions, or RMDs, begin, the IRS requires you to withdraw a certain amount from your tax-deferred retirement accounts each year. The calculation is fairly simple: your account balance is divided by an IRS life expectancy factor. As you get older, that factor declines, which means the percentage you are required to withdraw generally rises.
Now consider a retiree with a $2 million traditional IRA at age 73. If they take only the required minimum distribution each year and the remaining account grows at 7% annually, the numbers may be larger than many people expect.
At age 73, the first RMD would be about $75,000. By age 80, the annual RMD would rise to roughly $117,000. By age 85, it would be about $157,000.
And here is the surprising part: even after taking those required withdrawals every year, the account could still be worth about $2.5 million at age 85 under this simplified assumption.
In other words, the retiree could withdraw roughly $1.47 million in cumulative RMDs from age 73 through age 85 and still have a larger IRA balance than they started with.
That may sound like a good problem to have — and in many ways, it is. But from a planning perspective, it can create real tax complications. RMDs are generally taxed as ordinary income. Larger withdrawals can increase a retiree’s tax bill, affect Medicare premium surcharges, reduce flexibility around Social Security and portfolio withdrawals, and create taxable income whether the retiree needs the cash or not.
This is why RMD planning should begin before RMDs start.
For some retirees, the right strategy may include partial Roth conversions in lower-tax years. For others, it may involve drawing from tax-deferred accounts earlier in retirement, coordinating charitable giving through qualified charitable distributions, or adjusting which accounts hold higher-growth investments.
The goal is not to avoid taxes entirely. It is to avoid letting the tax bill become a surprise.
A growing IRA is a sign of financial strength. But without a thoughtful distribution strategy, it can also create a growing obligation to the IRS.