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The individual retirement account, or IRA, is a major part of nearly every modern retirement planner’s tool kit, providing the opportunity to contribute income and claim it as a deduction in the year the deduction was made. This tax advantage has made it a popular method to save for retirement while reducing tax bills, but hasn’t always been available. Until Congress established IRAs, workers primarily relied on company pensions to fund their golden years.
Employee Reitrement Income Security Act
The Employee Retirement Income Security Act, or ERISA, was the first piece of legislation to change the tax code to allow for tax deductible contributions to an IRA in 1974. ERISA laid the foundation for IRAs as investors know them today. It established the role of tax-deductible contributions -- which it limited to $1,500 per individual per year -- as well as the rules that allow funds invested in an IRA to grow without being subject to capital gains or income taxes. Under ERISA, only investors who weren’t covered by an employer-sponsored retirement plan could make deductible contributions to an IRA.
The Reagan Years
IRA contributions and deductions remained the exclusive benefit of only uncovered workers until 1981, when the Economic Recovery Tax Act lifted that limitation. Signed into law by President Ronald Reagan, ERTA allowed all workers, regardless of their employers’ retirement plans, to contribute and deduct up to $2,000 to an IRA. It also allowed deductible contributions of up to $250 to nonworking spouses. This change proved too liberal, and five years later, the 1986 Tax Reform Act placed limits on the deduction for high-income workers who were also covered by employer plans.
The '90s and On
While the reforms to IRA contribution rules established in the ’80s remained, subsequent legislation changed contribution and deduction rules slightly as the tax code evolved. By 1996, workers could contribute up to $2,000 to a nonworking spouse if they filed jointly. The following year, income thresholds for deduction limits for workers with employer plans were raised. Further modifications continued; in 2012, deductions stand at up to $5,000 per person, with an additional $1,000 contribution allowed for investors age 50 and older.
Although traditional IRAs have been a part of the investing landscape for nearly two generations, Roth IRAs are a relative newcomer to the retirement planning field. The 1997 Taxpayer Relief Act created Roth IRAs, with the same contribution limits as traditional IRAs. Unlike traditional IRAs, however, contributions made to Roth IRAs are never tax deductible. Instead, investors pay taxes on the funds placed in a Roth now, and receive distributions without owing income taxes.
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