Individual Retirement Accounts: A Fact Sheet

Individual Retirement Accounts: A Fact Sheet

Order Code 94-83 EPW
Updated February 22, 2001
CRS Report for Congress
Received through the CRS Web
Individual Retirement Accounts: A Fact Sheet
Paul J. Graney
Analyst in Social Legislation
Domestic Social Policy Division
Background
Individual retirement accounts (IRAs), established by the Employee Retirement
Income Security Act of 1974 (P.L. 93-406) to promote retirement saving, were limited at
first to workers (and spouses) who lacked employer pension coverage. Income tax was
deferred on both contributions and investment earnings. Annual contributions were limited
to the smaller of $1,500 or 15% of earnings. Eligibility was expanded to all workers and
their spouses by the Economic Recovery Tax Act of 1981 (P.L. 97-34). Annual
contributions were limited to the smaller of $2,000 or 100% of earnings. The Tax Reform
Act of 1986 (P.L. 99-514) continued tax deferral for IRA earnings, but it limited tax
deferrals for contributions to those from: (1) tax filers with no employer plan (for either
spouse); and (2) filers with employer pension coverage but whose adjusted gross income
(AGI) is below specified limits. The Taxpayer Relief Act of 1997 (P.L. 105-34) increased
these AGI limits, allowed penalty-free early withdrawals for higher education expenses and
first-home purchases, and authorized a new “Roth IRA” to provide tax-free income from
after-tax contributions and untaxed investment earnings.
Rules for 2001
Employed persons can contribute up to the lesser of annual earnings or $2,000 to an
IRA. A worker’s nonworking spouse also can contribute up to $2,000. However, for
workers with employer pension coverage, a full $2,000 contribution can be deducted from
gross income for tax purposes only if AGI does not exceed $33,000 ($53,000 for joint
filers). The allowable deduction declines to $0 over the next $10,000 of AGI.1 The
uncovered spouse of a worker with employer coverage may deduct IRA contributions in
full if AGI does not exceed $150,000, with deductibility phased out at $160,000. Tax is
deferred on an IRA’s investment earnings regardless of the taxability of new contributions.
1 The AGI limits for full deductibility were raised by P.L. 105-34 from $25,000 (single filers) and
$40,000 (joint filers). Further increases will occur, reaching $50,000 and $80,000, respectively,
by 2007. The phaseout interval will increase to $20,000 for joint filers in 2007.
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Up to $2,000 a year of after-tax earnings can be contributed to a Roth IRA by tax
filers with AGI up to $95,000 ($150,000 for joint filers). This contribution limit is phased
out for AGI of $110,000 ($160,000 for joint filers). Qualified withdrawals are not taxed;
thus, investment earnings may escape taxation completely.
An IRA’s assets must be held in trust at a financial institution and can be invested
only in interest-bearing accounts, financial securities, and certain precious metals. Funds
can be moved between IRAs once a year tax free if transferred within 60 days. Funds from
a tax-qualified pension plan also can be moved tax free to an IRA. Transfer of IRA funds
to a Roth IRA requires payment of income tax on funds that have not been taxed, but only
filing units (single or joint) with AGI of $100,000 or less can make such transfers.
Withdrawals of tax-deferred IRA funds are taxable when received. Taxable
withdrawals before age 59½ are assessed a 10% penalty tax except in case of: death;
disability; payment of a lifetime annuity; payment for higher education; a first-home
purchase; payment of excessive medical expenses; or payment of health insurance
premiums by jobless workers. To avoid a 50% penalty tax, withdrawals must begin after
age 70½ at a rate that will liquidate an IRA over the life expectancy of the accountholder
and a beneficiary deemed to be 10 years younger. A married couple with more than 10
years difference in their ages may use their longer joint life expectancy. This minimum
required withdrawal rule does not apply to Roth IRAs.
Trends
Assets held in IRAs have grown steadily, from $85 billion in 1983 to $2.5 trillion at
the end of 1999. However, new contributions have not been the main source of this
growth. New contributions made up 81% of growth in IRA assets in 1984 but accounted
for an estimated 2% of growth in 1997. This shift has been caused by a decline in
contributors after deductibility was limited in 1986, a steady stream of asset rollovers from
employer pension plans to IRAs, and especially investment earnings. New tax-deferred
contributions, which peaked at $38 billion in 1985, fell thereafter, amounting to only $8
billion in 1998. Changes to IRAs made by P.L. 105-34 may have stimulated new
contributions since 1997, however.
Besides the 1986 law, another factor in the decline in new IRA contributions has been
the lack of inflation indexing. Had Congress indexed the $2,000 contribution limit for
inflation since setting it in 1981, the limit would have been $3,789 in 2000. Likewise,
income limits on deductibility by workers with employer plans were not changed from
1986 to 1997. Had they been indexed, the $25,000 and $40,000 limits on full deductibility
would have been $39,279 and $62,847, respectively, in 2000. P.L. 105-34 increases these
limits in steps through 2007 but does not index them for inflation.
Because higher income workers have more discretionary income and higher tax rates,
they have contributed relatively more to IRAs than have lower income workers. In 1982,
56% of workers earning over $50,000 contributed to IRAs, compared to only 19% of
those with earnings between $20,000 and $25,000. After the 1986 law, participation rates
fell for both groups, to 23% and 13%, respectively. A survey by the Investment Company
Institute indicated that about 41% or 42.5 million households owned an IRA in June 2000:
33 million households had traditional IRAs, 10.4 million had Roth IRAs, and 7.4 million
had IRAs through their employer.