How the IRS Operates and Why Your Retirement Savings Might Not Be Yours

Photo by Olga DeLawrence

The Internal Revenue Service (IRS) is one of the most powerful financial institutions in the United States, responsible for collecting taxes and enforcing tax laws. While many people view it as a straightforward government agency, the reality is far more complex. The IRS is deeply embedded in nearly every financial decision Americans make—especially when it comes to retirement savings and inheritance.

For those who have spent a lifetime building their retirement accounts, the IRS plays a significant role in how much of that money they actually get to keep. And when those savings are passed down to the next generation, the government ensures it gets its share before families see a dime.

Retirement accounts like 401(k)s and traditional IRAs are built on tax deferral—a system that allows contributions to grow without immediate taxation. The catch? That money must be taxed eventually. Required Minimum Distributions (RMDs) ensure that once account holders reach a certain age—now 75 under the SECURE 2.0 Act—they must begin withdrawing funds, triggering taxable income.

When retirees pass away, their heirs inherit more than just a bank balance—they inherit a tax liability.

“The government keeps shifting the goalposts on retirement distributions, and most people don’t realize they’re walking straight into a tax trap,” says Michael A. Scarpati, CEO of RetireUS. “When your parents leave you their retirement savings, you don’t just get the money—you get the tax bill.”

Under the SECURE Act of 2019, non-spouse beneficiaries of an inherited IRA or 401(k) must withdraw the entire balance within 10 years. This prevents families from spreading withdrawals over decades, a strategy that previously kept tax rates lower. Now, these forced withdrawals can push middle-class heirs into higher tax brackets, significantly reducing their inheritance.

“What should have been a financial cushion turns into a major liability, and the IRS walks away with a bigger cut than most families expect,” Scarpati warns.

The IRS operates within a system that prioritizes tax collection efficiency over simplicity. The U.S. tax code is over 7,000 pages long, making it one of the most complicated financial rulebooks in the world. This complexity benefits the agency in multiple ways:

• Delayed Taxes Become Larger Taxes: By encouraging Americans to use tax-deferred accounts, the government ensures that withdrawals are taxed at higher income rates later in life.

• RMDs Guarantee Tax Revenue: By forcing distributions, the IRS ensures that it collects taxes on retirement savings whether retirees need the money or not.

• Inheritance Laws Maximize Payouts: The elimination of the “stretch IRA” means that large sums must be withdrawn—and taxed—faster, increasing government revenue.

This system is highly profitable for the IRS, which collected nearly $4.9 trillion in taxes in 2023 alone. Retirement account withdrawals, including forced distributions, contribute significantly to this total.

Despite the IRS’s tight grip on retirement savings, there are legal strategies to reduce tax exposure. Scarpati emphasizes that with careful planning, families can keep more of their wealth instead of handing it to the government.

“The system is designed to catch you off guard, but there are ways to outmaneuver it,” he explains. “If you want your kids to actually inherit your money—not hand it over to the IRS—you need to be strategic.”

One effective approach is Roth conversions. Unlike traditional IRAs, Roth IRAs allow for tax-free withdrawals, and they aren’t subject to required minimum distributions. Converting a traditional IRA to a Roth IRA does trigger an immediate tax bill, but it can prevent heirs from being taxed at even higher rates later.

Another option is strategic gifting. The IRS allows individuals to gift up to $18,000 per year per recipient (as of 2024) without triggering gift taxes. Over time, this can significantly reduce the taxable size of an estate while ensuring heirs receive money tax-free.

Most Americans don’t realize how deeply the IRS is embedded in their financial future until it’s too late. They are told to save diligently, invest wisely, and let their money grow—only to find out later that the government has structured the system to maximize its cut at every turn.

From forced withdrawals to sudden tax spikes, the IRS has created a system where retirement accounts don’t truly belong to those who save them. Without proper planning, the next generation may see their inheritance disappear into government coffers rather than remain in their family’s hands.

Scarpati puts it bluntly: “Once those required minimum distributions start, the tax bill is being locked in for generations.”

The only way to fight back is with proactive planning. Because if you don’t take control of your financial future, the IRS certainly will.