Tax Planning For Retirement Accounts Over 5 Million

The Tax Challenge of Having $5 Million or More in Retirement Accounts
Accumulating $5 million or more in retirement accounts is a significant achievement. It can also create a substantial future tax obligation that may not be obvious while the assets remain invested.

Traditional 401(k)s, IRAs, profit-sharing plans, and many defined-benefit arrangements generally receive favorable tax treatment while assets are contributed and growing. The trade-off comes later: distributions of previously untaxed amounts are generally included in ordinary taxable income.

For families with large retirement balances, required distributions and inherited-account rules can produce considerably more taxable income than they need for spending.

That does not make large retirement accounts undesirable. It means they should be incorporated into a coordinated lifetime tax, retirement-income, and estate strategy.

Required Minimum Distributions Can Become Substantial
Required minimum distributions, commonly called RMDs, are mandatory withdrawals from many tax-deferred retirement accounts.

Under current federal law, the applicable starting age depends on the account owner’s birth year. Current IRS guidance generally identifies age 73 as the present RMD age, with age 75 applying to certain younger taxpayers under current law.

The annual RMD is calculated using the prior year-end account balance and an IRS life-expectancy factor. As the owner ages, the applicable distribution period generally becomes shorter. If the account remains large, the required annual withdrawal may become substantial.

Except for previously taxed basis or another applicable exception, distributions from a traditional retirement account are generally included in ordinary taxable income.

Large RMDs can affect more than the federal income-tax bracket. They may also:

• Increase state income taxes
  
• Raise Medicare income-related premiums
  
• Increase the taxable portion of Social Security benefits
  
• Affect exposure to the net investment income tax
  
• Reduce flexibility for realizing capital gains
  
• Limit the usefulness of future Roth conversions
  

A family may not need an RMD to fund its lifestyle. The distribution is nevertheless required, and any amount not spent must be reinvested in a taxable account.

Failing to take the full required amount can also trigger an excise tax. The IRS currently states that the tax may equal 25% of the amount not distributed, potentially reduced to 10% when corrected within the applicable period. IRS RMD guidance

The Tax Obligation May Shift to the Next Generation
Large traditional retirement accounts also create planning questions for beneficiaries.

Spouses generally have more options when inheriting retirement accounts. Many nonspouse beneficiaries, however, are subject to a 10-year distribution period under current law.

That does not necessarily mean the beneficiary must withdraw exactly one-tenth of the account each year.

Depending on the beneficiary’s status and whether the original owner died before or after the required beginning date, annual distributions may apply during the 10-year period. In many cases, the entire remaining account must be distributed no later than the end of the tenth year following the owner’s death.

These distinctions are important and should be reviewed for the particular beneficiary and account. IRS beneficiary guidance

The tax problem is that adult children may inherit these accounts during their own peak earning years. Taxable retirement distributions are then added to salary, business income, investment income, and other household earnings.

A beneficiary may also be tempted to defer most withdrawals until the end of the 10-year period. That can create a very large taxable distribution in the final years.

A better approach may involve projecting the beneficiary’s income and evaluating distributions across multiple tax years. The appropriate schedule will depend on applicable distribution requirements, investment results, tax brackets, state residency, and the beneficiary’s financial needs.

Roth Conversions May Shift When the Tax Is Paid
One strategy families may evaluate is converting a portion of eligible traditional retirement assets into a Roth account.

A conversion generally creates taxable income in the year it occurs. In exchange, qualified Roth distributions may later be received free from federal income tax. Roth IRAs also do not require distributions during the original owner’s lifetime under current law.

The analysis involves deciding whether paying tax today may produce a better long-term result than retaining the traditional account and paying tax on future distributions.

Factors to consider include:

• The owner’s current marginal tax rate
  
• Projected future RMDs
  
• Expected future tax rates
  
• State income taxes
  
• Medicare premium thresholds
  
• Available cash to pay the conversion tax
  
• Investment horizon and life expectancy
  
• The beneficiaries’ expected tax circumstances
  
• Charitable intentions
  

Conversions do not have to be an all-or-nothing decision. Some families may evaluate partial conversions over several years, particularly during a period after retirement when employment income has declined but RMDs have not yet begun.

A conversion can still be inappropriate if it pushes income into an unnecessarily high bracket, creates excessive Medicare costs, or uses retirement assets to pay a tax that the family was unlikely to owe at the same rate later.

The strategy should be tested through a multiyear tax projection rather than evaluated one year at a time.

Qualified Charitable Distributions May Help Charitable Families
Families who are already charitably inclined may also consider qualified charitable distributions, or QCDs.

Under current rules, an eligible IRA owner who has reached age 70½ may direct a qualifying distribution from an IRA to an eligible charitable organization. When properly completed, the distribution may be excluded from taxable income and can count toward the owner’s RMD.

A QCD is different from withdrawing funds personally and later writing a check to charity. The funds generally must pass directly from the IRA trustee to an eligible organization, and donor-advised funds do not qualify to receive QCDs.

The annual limit is indexed and may change, so the applicable amount should be confirmed for the year of the gift.

QCDs can be useful when charitable giving is already part of the family’s plan. They should not be viewed as a way to retain money that would otherwise be distributed.

Coordinate Investments Across Account Types
Retirement-account planning is not only about withdrawals. It also involves determining which investments belong in each account.

Different investments produce different types of taxable income. A coordinated asset-location strategy may place more tax-inefficient assets inside tax-deferred accounts while holding relatively tax-efficient investments in taxable accounts.

This cannot be done mechanically. The allocation must also account for:

• Investment risk
  
• Withdrawal timing
  
• Liquidity needs
  
• Concentrated positions
  
• Expected returns
  
• Estate objectives
  
• The tax characteristics of each account
  

For example, placing all fixed income inside a traditional IRA may reduce current taxable interest, but it could also increase the future value of an account subject to ordinary-income taxation. Conversely, placing the highest-growth assets in a Roth account may potentially increase the amount of future tax-free wealth, but it can also affect the portfolio’s overall risk structure.

Asset allocation and asset location should therefore be designed together.

Build a Multiyear Retirement-Tax Projection
The key question is not simply how large the retirement accounts are today. It is how those accounts may be taxed across the owner’s lifetime and after they pass to beneficiaries.

A meaningful analysis should project:

• Annual retirement spending
  
• Social Security and other income
  
• Future RMDs
  
• Potential Roth conversions
  
• Medicare income-related premiums
  
• Charitable distributions
  
• Taxable-account withdrawals
  
• State income taxes
  
• Beneficiary circumstances
  
• Expected account values under different market scenarios
  

The projection will not predict future tax laws or investment returns. Its purpose is to identify the decisions available today and compare their potential trade-offs.

Begin While Flexibility Remains
A large retirement account is not a problem to eliminate. It is an asset with a deferred tax obligation that must be managed intentionally.

Planning is generally easier before RMDs begin, before income is forced into higher brackets, and before the account passes to the next generation.

Tidecrest Wealth Management helps families coordinate retirement income, investment management, tax planning, charitable giving, and estate considerations within one long-term strategy.

If a significant portion of your wealth is held in retirement accounts, we invite you to schedule a conversation with our team and evaluate how those assets fit into your broader financial plan.

This material is provided for educational purposes only and should not be considered individualized investment, tax, legal, or charitable advice. Retirement-account and beneficiary rules depend on the account type, applicable law, the original owner’s circumstances, and the beneficiary’s status. Roth conversions generally create taxable income, and qualified charitable distributions are subject to eligibility and procedural requirements. Consult qualified professionals before implementing any strategy.