The Hidden Tax Trap in a Large IRA — and How to Plan Around It

A large IRA is one of the best financial problems to have, until RMDs arrive and push you into a tax bracket you never anticipated. More and more retirees and people nearing retirement have spent decades saving in the 401(k) plans. Through consistent contributions, employer-matching contributions, and strong market performance, that 401(k) may have grown to more than they ever expected. While this is a good thing, it can have unintended consequences later. Required minimum distributions (RMDs) can push retirees into higher tax brackets late in retirement if not addressed before it’s too late.

Consider a client who was a diligent saver, and had employer stock in an employee stock ownership plan (ESOP) that had performed extremely well. As a result, he had a large IRA balance in his mid-sixties. Not only were he and his wife concerned about their own taxes, but they had one daughter who would one day inherit the IRA, and under current rules she would have to deplete the account within 10 years when both her parents were gone. Before exploring what strategies we reviewed, it is important to understand how RMDs work.

Under current law, when a person reaches age 73 they are required to start taking distributions from 401(k) and IRA accounts. These accounts allowed for years of tax deferral, and eventually the IRS wants to start collecting taxes on the assets. The distributions are based on the account balance at the end of the previous year, divided by a factor published in a table by the IRS. The factor is based on life expectancy, so it isn’t a flat percentage or dollar amount that is required to come out each year. The percentage of the account to be distributed goes up each year, slowly at first, and then faster as you get older. That, plus potential account growth from market performance can create surprisingly large distributions later in retirement.

In a situation like the one described, it may be possible to calculate a roth conversion strategy to utilize lower tax brackets before his RMDs began. Paying taxes earlier can feel counterintuitive, but the case for conversions can be strong depending on a client's assets, age, and goals, particularly when leaving a tax-free inheritance is a priority. A Roth IRA, unlike a traditional IRA, passes to heirs income-tax-free, meaning the daughter in this scenario inherits an account she can draw down over 10 years without an additional tax burden.

One way to potentially amplify the impact of roth conversions would be to execute them during downturns in the market. Doing the conversion during a downturn can have the double effect of converting a higher percentage of the IRA, and allowing the potential recovery to occur in the tax-free account. In other words, you convert more shares for the same tax cost, and when the market recovers, that growth happens inside the Roth rather than the traditional IRA.

Another option, starting at age 70 ½ is qualified charitable distributions. As of 2026, individuals older than 70 ½ can distribute up to $111,000 from an IRA directly to a qualified charity and satisfy all or part of their RMDs. For those that are charitably inclined, this might be a good way to satisfy philanthropic goals and reduce taxes, especially since many taxpayers are no longer itemizing deductions.

Having significant assets in an IRA is a good thing, but it is important to be proactive and understand the impact of RMDs later in retirement. Depending on your age, mix of assets, and your goals there may be strategies that help smooth the tax rates you’ll pay, but it requires careful planning to coordinate other income sources, tax brackets, and other taxes such as the income-related Medicare adjustment amounts (IRMAA). IRMAA is a Medicare surcharge applied to higher-income retirees that can meaningfully increase Part B and Part D premiums, and large RMDs can trigger it unexpectedly. Paying taxes today might sting, but it could pay off down the road.

If you're wondering whether your IRA could create tax challenges later in retirement, that's exactly the kind of question worth exploring in a planning conversation. Book a free call here.

This content is for educational purposes only and does not constitute personalized investment or tax advice. Tax laws are subject to change. Please consult a qualified tax professional before implementing any tax strategy. Past performance is not indicative of future results.