The Downside to IRAs: No Such Thing as a Free Lunch


Ah the IRA. Now that pension plans have all but gone the way of the dinosaur, the IRA has been the retirement vehicle of choice for the American middle-class. Since it’s inception, the IRA has been touted as a “no-brainer.” Far and wide, financial planners and financial gurus alike feel safe in advising that you “max out” your IRA. 

The IRA does have some great benefits. A traditional IRA is a retirement account that you can contribute your earned income to before it gets taxed. This means that you do not pay the tax on the money you contribute at the time it’s contributed. 

An IRA also gives the benefit of tax free growth on the money you contribute. This means that if any of the money in the IRA is invested, the growth on that money is not taxed—at the time of the growth. Unfortunately, these benefits are only available if you’re willing to lock up your money until age 59 1/2. Pulling money out before that age will result in a 10% penalty. 

An IRA doesn’t so much save you from tax than it defers the tax on the money you contribute. At some point, whenever the money is pulled out, you will pay tax. And by the way, you have to pull money out. You may have heard of the required minimum distribution or “RMD.” The RMD forces you to pull out money and pay tax on it, so that you don’t get to sit on the retirement account and defer the tax until your death.

So, let’s say you’ve contributed your entire career to an IRA. You have a sizable amount saved and you’re depending on it to live off of for the rest of your life. However, you end up needing long-term care, similar to 70% of other individuals who make it past retirement age. You begin to incur cost of anywhere between $5,000 and $15,000 per month. You want to protect what you have in your IRA and you’d rather not see it all go to a facility. 

The problem is, the only way to protect the IRA is to pull the money out. If you pull the money out, you get taxed on all of it. However, an even worse option is to use it to pay for long term care. Because, when you pull money out to pay the facility, you get taxed on it and it gets spent. 

In other words, an IRA can put you in a tough spot if you’re trying to protect the hard-earned money from the risks you face as you age. 

I’m not saying that IRAs don’t have their place. However, they might not be all they’re cracked up to be when we look at what happens after retirement. 

If you have an IRA and are not in need of long-term care, you may want to explore an IRA to trust conversion to protect your retirement. Additionally, you can utilize financial instruments like life insurance to save money tax free. 


Brenton Begley

Attorney at Law

in Estate Planning, Long Term Care Planning, Tax Planning by Greg McIntyre Leave a comment
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