Ed Slott: Traditional IRA functions like a joint account with IRS

Ed Slott, a certified public accountant who advises on retirement tax rules, warned that a traditional IRA effectively operates like a joint account with the Internal Revenue Service because the government retains a tax claim on pre-tax contributions and investment earnings.

Slott explained that money contributed to a traditional IRA is often tax-deductible at the time of contribution, grows tax-deferred, and becomes taxable when distributed. He pointed to required minimum distribution rules, taxes on distributions and changes to beneficiary rules as reasons account owners and heirs must plan with the IRS tax claim in mind.

Under current federal rules, account owners must take required minimum distributions once they reach a specified age. Many non-spouse beneficiaries must empty inherited tax-deferred accounts within a ten-year window. Slott noted that the IRS can tax distributions and impose penalties for missed RMDs; Congress has reduced the maximum penalty for failing to take an RMD from 50% of the missed amount to 25%, and to 10% if the error is corrected quickly.

Slott recommended several strategies to limit future tax exposure. Converting a traditional IRA to a Roth IRA requires paying tax on the converted amount now in exchange for tax-free qualified withdrawals later. Qualified charitable distributions can satisfy RMDs without increasing taxable income. He also urged account holders to review and update beneficiary designations to reflect current intentions and to manage tax outcomes for heirs.

“When you fund a traditional IRA, you’re deferring taxes, not avoiding them,” Slott warned. He added that large distributions can push retirees into higher tax brackets, affect the taxable portion of Social Security benefits and increase Medicare Part B and Part D premiums through income-related monthly adjustment amounts.

Slott noted differences between account types: Roth IRAs are funded with after-tax dollars and qualified withdrawals are tax-free for the original owner, limiting the IRS claim once statutory conditions are met. However, inherited Roth IRAs remain subject to distribution rules that require attention.

Slott identified recent federal changes that eliminated the so-called stretch IRA for many beneficiaries and tightened distribution timelines, shifting tax burdens into shorter windows and increasing the need for planning by account owners and heirs. He recommended working with a tax or financial professional to evaluate whether conversions, systematic distributions or charitable giving strategies align with an individual’s tax and estate plan.