The Hidden Risk of Large IRAs

For decades, high earners were told to do one thing...

Defer taxes.

This meant maxing out your 401(k), Sep IRAs, and personal/spousal IRAs. For

many successful professionals and business owners, this was a proven way to

reduce taxes in your working years. But what happens when these accounts

balloon – sometimes doubling or tripling – in the years leading up to retirement?

If you’ve built a seven-figure IRA portfolio, you may be sitting on what many

advisors call a ticking tax time-bomb.

Let’s break down the hidden risks these accounts create, and more importantly,

what we can do about them.

The Real Issue – Tax Deferral isn’t Forever

Traditional IRAs and pre-tax 401(k) plans offer an immediate tax deduction.

The flip side is that when distributions (withdrawals) are made from these

accounts, all the money taken is taxable in the year of the distribution.

Because taxes aren’t paid until you make a withdrawal, our old friend Uncle Sam

can get impatient – and that’s why Required Minimum Distributions (RMDs) exist.

Once you reach age 73, RMDs begin. And those distributions are taxed as ordinary

income — not capital gains.

If you’ve accumulated significant wealth in pre-tax retirement accounts, those

RMDs can become substantial, and the percentage you must take out increases

each year for the rest of your life.

Without proper tax planning, this can mean:

• Higher marginal tax brackets

• Increased percent of Social Security taxed

• Higher Medicare Premiums (IRMAA)

• Major tax hikes for a surviving spouse

Hidden Risk 1: “Tax Bracket Creep” in Retirement

Most investors assume their tax rate will drop in retirement. For some, it does.

But many big savers experience the opposite. Between RMDs, Social Security

income, pensions, and investment income, you may find yourself earning as much

(or more) taxable income than during your working years.

This keeps you in a high tax bracket!

Hidden Risk 2: The Widow’s Penalty

This is one of the most overlooked planning risks.

When one spouse passes away, the surviving spouse typically moves from

Married Filing Jointly to Single tax status.

That means:

• Narrower tax brackets

• Lower income thresholds

• Potentially higher Medicare premiums

If the IRA balances remain large, the same income may now be taxed at higher

marginal rates. In other words, the surviving spouse may pay more tax on the

same dollars.

Hidden Risk 3: Income at the Wrong Time

RMDs don’t consider market conditions.

They don’t care whether the market is down.

They don’t care about your personal spending needs.

A study conducted by Morningstar, a major market researcher, found that poor

withdrawal timing can increase the chances of running out of money early in

retirement by more than 38%! 1

Because RMDs are mandatory, we must work proactively to reduce their impact;

through strategies like Roth conversions or charitable giving.

Hidden Risk 4- Passing a Tax Burden to the Next Generation

Under recent tax law changes, most non-spouse beneficiaries must withdraw

inherited IRA assets within 10 years. 2

That means that if your child inherits a large IRA during their peak earning years,

they could be forced to withdraw themselves into much higher tax brackets.

This is one of the many ways the IRS taxes generational wealth transfers. What

looks like a generous inheritance may create a significant tax pitfall for your loved

ones.

Crucially, if you convert some of your IRAs to Roth before it’s inherited, your

beneficiaries will receive the Roth portion 100% tax-free.

What Can You Do About It?

The end goal isn’t necessarily to eliminate pre-tax accounts.

It’s about managing our assets wisely and respecting how the different taxable

natures of our accounts dictate strategy.

To start, consider these simple strategies for your own accounts:

• Gradual Roth conversions during lower-income years

• Filling up your current tax bracket intentionally

• Matching RMD timing with charitable strategies (such as Qualified

  Charitable Distributions)

• Diversifying your “tax buckets” (taxable, tax-deferred, and tax-free

  accounts)

The earlier planning begins, the more flexibility you typically have.

Waiting until RMDs begin can limit your options.

Final Thoughts

If you’ve built substantial wealth inside pre-tax retirement accounts, you’ve done

many things right.

The next step is ensuring those savings are distributed in the most tax-efficient

way possible — for you and for the next generation.

A proactive review today could mean significantly less tax paid over your lifetime.

And that’s an effort worth making.

1 Morningstar.com February 8, 2024 https://www.morningstar.com/business/insights/blog/retirement/systematic-

withdrawal-approaches?utm_source=chatgpt.com

2 Internal Revenue Service, Publication 590-B https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-beneficiary

Investment advisory services offered through Alphastar Capital Management, LLC, a SEC-registered investment adviser.  SEC registration does not constitute an endorsement of the firm by the SEC nor does it indicate that the adviser has attained a particular level of skill or ability.  Fixed insurance products are offered through Ironwood Financial Group, and Alphastar Capital Management is not involved in the offer, recommendation, sale or management of commission-based fixed Insurance products. Alphastar Capital Management and Ironwood Financial Group are separate and independent entities. This is for informational purposes only and is not intended as legal, tax or investment advice or a recommendation of any particular security, investment product or investment strategy.