Monday, May 9, 2011

A complete history of American individual retirement plans

Individual Retirement plans- an overview

Individual Retirement Accounts (IRA) allows you to contribute to your retirement via a beneficial tax structure. The Employee Retirement Income Security Act (ERISA) created the first IRA in 1974 to allow tax deductible contributions of $1,500 per year. Since then, Congress has made many useful changes and a few restrictions in the IRA. Now, almost everyone can have an IRA, even if it is provided by your employer. You can establish an IRA account through new contributions, through rollover from an employer sponsored retirement plan or as an inheritance.

IRA reforms

At first, IRAs were limited to workers who were not covered by an employment based retirement plan.  In the year 1978, The Revenue Act established the SEP (Simplified Employee Pension Plan) IRA for small business owners. The Economy Recovery Act of 1981 allowed IRS for all tax payers, in addition to those employees who are not covered by an employee retirement plan. The maximum annual contribution amount was also raised to $2,000.

The Tax Reform Act of 1986 stopped tax deductible contribution for higher income employees. The Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) IRA was introduced by the Small Business Job Protection Act of 1996, which allowed non working spouses to make more contribution to a jointly filed IRA.

The Tax Payer Relief Act of 1997 created a Roth IRA and Education IRA, which permits you to make non deductible contributions to an account that can be redeemed in the future. The law relieves you from paying any tax penalty and it allows tax free withdrawals under certain situations.

Additional changes were made to the IRA in 2001 by the Economic Growth and Tax Relief Reconciliation Act (EGTRRA). It increased the maximum contribution level. It also included a special catch-up clause that allows people aged 50 and above to make contributions. Nonrefundable credit is also offered for some contributions to an IRA plan. In 2006, Congress made a provision to allow high income employees to contribute to Roth IRAs. The Pension Protection Act of 2006 allowed tax free gifts from an IRA for individuals aged 70 ½ and above. Lower income individuals can get an income tax credit under this act.

Traditional Individual Retirement Plans

The traditional IRA introduced by the ERISA in 1974 offer you the benefit of tax deferred growth. This means that you need not pay taxes on your account, until you withdraw the amount you have contributed to the IRA account. You may be qualified for a full or partial tax deduction on the contributions made.

How traditional IRA works

Traditional IRA helps save pre-tax dollars that can be used after retirement. It can be opened at various places, such as a mutual fund company, brokerage or at your local bank. The money in traditional IRA can be invested in stocks, mutual funds, bonds or CDs.

The current (2011) annual contribution limit is $5,000 or 100% of your compensations, whichever is less. The maximum contribution limit is $6000, if your age is 50 or more. If you are an individual aged 50 or more, you may plan to contribute an additional amount of up to $1,000 to your IRAs.

Eligibility requirements

Traditional IRA is open to anyone, who has earns an income. However, there are certain restrictions for deducting the contributions. The amount of income earned by the individuals is used to determine the amount of contributions that are deductible.

If you are covered by a retirement plan at work in 2011, deductibility for traditional IRA plan is as follows


If you are a single (an active participant of IRA plan) and your MAGI (Modified Adjusted Gross Income) is $56,000 or less, you may be eligible to deduct your full contribution. If your income is more than $56,000 but less that $65,999, you will be eligible for partial deduction. If your income is $66,000 or more, you are not eligible for deduction.


If you are filing a joint return and are an active participant of IRA plan, you may be eligible to deduct your full contribution, provided your MAGI is $90,000 or less. Partial deduction may be allowed, if your MAGI is between $90,001 and $109,999. You are not eligible for deduction, if your income is $110,000 or more.

Joint, but not an active participant of an IRA plan

If you are filing a joint return and your spouse is under an IRA plan, contribution is fully deductible, if your Magi is $169,000 or less. Partial deduction is allowed, if your income is between $169,001 and $178,999. If your income is more than $179,000, you are not eligible for any deduction.

Non participants in a retirement plan

If you are an IRA investor, who is not covered by a retirement plan and are single or have a spouse without a retirement plan at work, you can contribute up to $5,000 in 2011. Your compensation must be equal to or exceeded the contribution amount. You can then deduct the full contribution. There are no maximum MAGI limitations in this case.

Unemployed spouse

If you are an unemployed spouse or a spouse not covered by a retirement plan at work, you can make tax deductible contributions to IRA, no matter whether your spouse is under a retirement plan at work or not. 

You can contribute up to $5,000 in 2011, as long as you file a joint tax return with your spouse. If your spouse is employed and is covered by a retirement plan, you can make tax deductible contributions to an IRA, if your combined MAGI is $169,000.

Distribution requirements

Traditional IRA distribution begins at the age of 70 ½. If you do not take at least the required minimum distribution after 70 ½ years, you are subject to penalties. If you withdraw money before 59 ½ years, you are subject to an early withdrawal penalty and you also owe tax.

When penalty free early withdrawals are allowed?

You may withdraw money without incurring any penalty before the age of 59 ½ for any of the following reasons –

  • If you want to buy your first home, you may be able to withdraw up to $10,000
  • You may withdraw in order to meet qualified higher education expense for yourself, your spouse, child or grandchild.
  • Penalty free withdrawal is allowed to meet medical expenses and health insurance premiums.
  • If you are charged with a levy by the IRS, you may withdraw earlier.
  • Disability or death
These withdrawals are taxed as normal income.