An Individual Retirement Account (IRA) is a savings account designed to help you save for retirement. IRAs offer various tax benefits, including tax-deductible contributions and tax-deferred growth. This means you can deduct your IRA contributions from your taxable income for the year you make them, and your IRA earnings will grow tax-deferred until you withdraw them in retirement (age 59.5 or older).
There are two main types of IRAs: Traditional IRAs and Roth IRAs. Traditional IRAs offer tax-deductible contributions, but your withdrawals in retirement will be taxed as ordinary income. Roth IRAs allow you to make non-deductible contributions, but your withdrawals in retirement will be tax-free.
The annual IRA contribution limit is capped at a certain amount. For 2023, the contribution limit is $6,500 for individuals under 50, and $7,500 for individuals 50 and older. If you have a higher income (over $153,000 for individuals, $228,000 for couples) or if you are married and file jointly with a spouse who does not have an IRA, you can contribute more.
The concept of individual retirement arrangements dates back to the 1960s when the idea was first introduced. At that time, most retirement savings options were employer-sponsored plans like pension plans. However, not all employees had access to these plans, creating a growing need for retirement savings options that individuals could control.
In 1974, Congress passed ERISA (the Employee Retirement Income Security Act of 1974), which created the IRA. The initial contribution limit was $1,500 per year, and most contributions were tax-deductible.
Over the years, several changes have been made to IRAs. Contribution limits have increased, and now there are two main types of IRAs: Traditional IRAs and Roth IRAs, along with some variants that we will outline later. Traditional IRAs allow for tax-deductible contributions, but withdrawals in retirement are taxed as ordinary income. Roth IRAs require after-tax contributions, but withdrawals in retirement are tax-free.
IRAs have become a widely used retirement savings option for millions of Americans. They offer various tax benefits and investment choices and can be an effective tool for retirement savings.
Here are some key milestones in IRA history:
* 1974: ERISA was passed, creating IRAs.
* 1981: The Economic Recovery Tax Act of 1981 increased individual contribution limits to $2,000 per year and made IRAs available to anyone with income and their spouses.
* 1986: The Tax Reform Act of 1986 limited the deductibility of Traditional IRA contributions for high-income earners.
* 1997: The Taxpayer Relief Act of 1997 created the Roth IRA.
* 2001: The Economic Growth and Tax Relief Reconciliation Act of 2001 raised the contribution limit to $3,000 per year and allowed for catch-up contributions for those aged 50 and older.
* 2006: The Pension Protection Act of 2006 increased the contribution limit to $5,000 per year and allowed individuals aged 50 and older to make an additional $1,000 catch-up contribution annually.
* 2012: The American Taxpayer Relief Act of 2012 raised the contribution limit to $6,000 per year and allowed individuals aged 50 and older to make an additional $500 catch-up contribution annually. Limits for married couples filing jointly vary.
Today, IRAs remain a highly useful tool for retirement savings. They offer various tax benefits and investment options and can be an effective tool for achieving retirement goals. Let’s take a look at how IRAs work, and then we will explore the main differences between the different types of IRAs.