Dear Liz: I’m 76 and retired. During the decades I worked, I contributed to my IRA yearly using my tax refund or having money deducted from my paycheck. No one told me I would have to pay taxes on this when I turned 70. For the past six years, I have been required to withdraw a certain percentage of this IRA money and pay taxes on it. Is there ever going to be an end to this? Do I have to keep paying taxes on the same money every year? And what about when I pass away, do my children have to keep paying?
Answer: Ever heard the expression, “There’s no such thing as a free lunch”?
You got tax deductions on the money you contributed to your IRA over the years, and the earnings were allowed to grow tax deferred. Those tax breaks are designed to encourage people to save, but eventually Uncle Sam wants his cut.
Also, you aren’t “paying taxes on the same money every year,” because the money you withdraw has never been taxed. Plus, you’re required to take out only a small portion of your IRA each year starting at 70½. The required minimum distribution starts at 3.65% and creeps up a bit every year, but even at age 100 it’s only 15.87% of the total. You can leave the bulk of your IRA alone so it can continue to grow and bequeath the balance to your children.
Your heirs won’t get the money tax free. They typically will be required to make withdrawals to empty the account within 10 years and pay income taxes on those withdrawals. Previously, they were allowed to spread required minimum distributions over their own lifetimes. Congress recently changed that to require faster payouts because the intent of IRA deductions was to encourage saving for retirement, not transfer large sums to heirs.
The Roth IRA is an exception to the above rules. There’s no tax deduction when you contribute the money, but the money can be withdrawn tax-free in retirement or left alone — there are no required minimum distributions. Your children would be required to start distributions, but wouldn’t owe taxes on those withdrawals.
and, i think Congress gave me the option to switch my traditional IRA when the Roth was created. i chose not to. the benefit of the IRA was sold to us as a way to lower our taxable income thinking we would retire with much less income, therefore much less tax would be paid.
Most people are better off leaving the money where it is for exactly the reason you mention: their tax bracket drops, sometimes significantly, in retirement. It usually doesn’t make sense to pay taxes at a higher rate if the money can be accessed at a lower rate later. Conversions can make smart, though, if future required minmimum distributions will send their tax bracket higher in retirement or if they want to get more tax-free money to heirs. But you’d want a skilled CPA to model potential scenarios, since late-in-life conversions can result in higher Medicare premiums, higher taxes on Social Security benefits and higher capital gains taxes, among other fallout.