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The original individual retirement account offered deductible contributions, up to an annual limit of $2,000. Investors paid taxes on the account gains only when they withdrew the money. At retirement age, in theory, the tax rate on these gains would be lower because you were no longer earning money from employment. Federal lawmakers later came up with a new version of the account known as the Roth IRA.
In 1997, Congress passed the Taxpayer Relief Act. With this law, a new type of IRA became available. These accounts are named for the late U.S. Sen. William Roth of Delaware, who sponsored the legislation that created them. Starting in 1998, the new Roth IRA allowed investors to make after-tax contributions and tax-free withdrawals, the reverse of the traditional IRA arrangement.
Traditional IRAs had been available since the Employee Retirement Income Security Act of 1974. The original law allowed tax-deductible contributions of up to $1,500 per year. It did not allow contributions to an IRA as well as an employer-sponsored savings plan. However, in 1981, the law changed to allow investors to own both an IRA and an employer plan such as a 401(k). The law was intended to help middle-class workers save, but some lawmakers believed high-income workers were using the rules to evade income taxes. In 1986, Congress changed the law once again. Fully deductible contributions to IRAs for those who also had employer plans were limited to those workers earning $25,000 if single, or $40,000 if married.
The law on Roth IRAs allows you to deduct your original contributions to the account at any time, without tax or penalty, since the contribution money was already taxed. However, if you convert funds to a traditional IRA, you must wait at least five years, or until you reach age 59 1/2, before you can withdraw this "rollover" money tax free. Income from these contributions is not tax-free until you reach 59 1/2 and the five-year period has passed. These rules were designed to prevent people from simply converting their traditional IRA to a Roth and start making tax-free withdrawals, defeating the original purpose of the IRA: keeping the money for retirement.
Limits on Contributions
Since Roth IRAs began, Congress has frequently adjusted the rules on contributions. The basic contribution limit as of 2013 is $5,500, with an additional $1,000 "catch-up" contribution for savers age 50 or above. The IRS starts to phase out contributions once you reach $178,000 in adjusted gross income, for married, joint tax filers, or $112,000, for those filing as single or head of household. The principle difference between Roth and traditional IRAs remains the tax rule on contributions and withdrawals. In addition, owners of a Roth can keep the money in the account indefinitely, while traditional IRAs require you to start making withdrawals at age 70.
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