The IRA: Younger than Most Retirees
While saving for retirement and building a net worth have been part of our lives for generations, the IRA itself is actually younger than most retirees. IRAs were born in 1974 as part of ERISA, the Employee Retirement Income Security Act. Recognizing that not all workers were covered by a pension plan, where corporate or government employers save for their employees’ retirements, congress put these shiny new retirement account laws into place allowing Individuals (I) to own their own Retirement (R ) Accounts (A) in a tax-favored manner. Contributions could be made on a tax-deductible basis, growing and compounding tax-deferred, with future income withdrawals taxed at ordinary income tax rates in the year of each withdrawal.
It took some time for our legislators to recognize that IRAs had some growing up to do. In 1974, individuals could contribute up to $1,500 per year. It took until 1982 for that limit to be raised to $2,000 per person per year, with that ceiling staying in place until IRA’s celebrated their 27th birthday in 2001. That’s when the Economic Growth and Tax Relief Reconciliation Act temporarily allowed for contribution limits to be pegged to inflation. Catch-up provisions were also introduced, allowing retirement savers ages 50 and older to put away an extra $500 each year. The Pension Protection Act of 2006 permanently allowed contributions to be indexed to inflation. Prior to the temporary provision in 2001, it took an Act of Congress to increase the contribution limits, which is why we only had two raises in nearly three decades (1). More recently, from 2019 - 2022, qualifying individuals could contribute up to $6,000 per year or an amount equal to their 2022 income, whichever is less. 2023 saw a rise in the cap to $6,500 or an amount equal to their 2023 income, whichever is less. The annual catch-up provision for savers 50 or over has also been increased to $1,000.
A baby brother to the IRA named Roth was born in 1997, thanks to years of work by Senator William V. Roth Jr., R-Del. Roth IRAs would now allow retirement savers to contribute after-tax dollars which could grow and be withdrawn tax-free, following applicable law. The baby brother became the favorite for many, but still shares many of the same traits of its older IRA sibling.
While the tax treatment differs between traditional and Roth IRAs, they have a lot in common. Among other things, both are subject to income limitations for the saver to be eligible for tax-favored contributions, and both are subject to penalties if one exceeds annual aggregate contribution limits. They both offer tax-favored growth, as well as the freedom to choose your own investments inside of the accounts. Most notably, both IRAs and Roth IRAs allow us to own our own retirement accounts, placing both the responsibility and control in our hands versus a government or corporate entity. We can also name any beneficiary we wish: spouses, children, other relatives or meaningful persons in our lives, trust entities and charities. Note that the tax treatment will differ by the inheritor, so please make informed choices or seek guidance from a financial professional.
The Individual Retirement Account has matured to be a powerful retirement partner in many people’s retirement plans, albeit being younger than many retirees themselves.
- Congressional Research Service. Individual Retirement Account (IRA) Ownership: Data and Policy Issues.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply
LouAnn Schulfer is co-owner of Schulfer & Associates, LLC Wealth Management and can be reached at (715) 343-9600 or louann.schulfer@lpl.com. www.SchulferAndAssociates.com, louannschulfer.com or louann.biz
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