Happy Anniversary to the Roth IRA!

Happy Birthday Roth IRAHappy Anniversary to the Roth IRA! Celebrating 20 years in 2018.

IRAs started small. The first IRAs created in 1974 had two purposes:

1.  As a retirement savings vehicle for employees not covered by employer retirement plans; and
2.  As an account to hold distributions from employer plans on separation from service

These first IRAs could accept annual contributions not exceeding the lesser of $1,500 or 15% of earned income, only from employees who were not covered by an employer’s qualified retirement plan. Distributions from them were subject to still familiar rules — being taxable income at ordinary rates, with required minimum distributions (RMDs) starting at age 70½, and distributions before age 59½ subject to 10% penalty. They could accept rollovers from company plans.

In 1981, Congress loosened the rules to let anyone deduct an IRA contribution, whether covered by an employer plan or not and increased the contribution limit to $2,000. Annual contributions exploded upward by almost 800%. At this point 401(k) plans did not exist, so this was the only way to save salary on a tax-deferred basis.

In 1986, Congress re-established income caps on eligibility for active participants in employer plans to contribute, and annual contributions plunged back downward by nearly 80%, never recovering to their former height.

However, Congress also created nondeductible IRA contributions, and IRAs continued to receive growing numbers of rollovers, even as they faded as a savings vehicle.

Then in 1998, Congress created the Roth IRA which was in many ways the opposite of the traditional IRA. Most notably, contributions to Roth IRAs were not deductible while distributions from them were tax free. Traditional IRAs could be converted to Roth IRAs with pre-tax funds being included in taxable income when moved into a Roth. Thereafter, Congress gradually loosened the rules on Roths.

In 2002, it permitted after-tax plan funds to be rolled over into IRAs which could then be converted into Roth IRAs.

In 2007, non-spouse company plan designated beneficiaries became able to do direct transfers of inherited plan funds to inherited IRAs, including Roth IRAs. In 2010, this provision became mandatory.

In 2008, it became possible to make Roth IRA conversions directly from company plans [such as 401(k)s and 403(b)s], without first rolling over the funds into a traditional IRA and converting them into a Roth.

In 2010, both the $100,000 income limit and the rule prohibiting taxpayers who are married filing separately from making Roth IRA conversions were removed. This was the biggest event for Roths since their creation — because it enabled anyone to make a Roth IRA conversion, in any dollar amount. This opened the floodgates for Roth conversions.

Thus, our modern era of potential full use of Roth IRAs began.

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About Roth IRAs

Roth IRA iconAs of 2017 you could save up to $5,500 in an IRA, with an extra $1,000 in savings allowed if you’re 50 or older. If you’re eligible to contribute to a Roth IRA, you could withdraw that money tax free in retirement.

Roth IRA iconTax-free withdrawals. Roth IRAs are funded with after-tax money. No upfront tax deductions, but your money is allowed to grow without taxation throughout the life of the account as long as no unqualified withdrawals are made.

Roth IRA iconNo mandatory withdrawals, including required minimum distributions.

10% penalty on ineligible withdrawals

Roth IRA iconNo penalties on eligible withdrawals before age 59½. Although the purpose of a Roth is to save for retirement, and your money can grow only if you leave it in the account, you can withdraw your contributions at any time, tax free and without penalty.

Roth IRA iconContribution limits vary based on your income. There are income limitations as to who can contribute, but they tend to exclude only around 10% of the population who happens to be well off, so this is a retirement tool geared toward lower-, middle-, and upper middle-class Americans.

Roth IRA iconNo age limits on contributions. You can even continue making contributions past the year you turn 70½, unlike a traditional IRA.