Welcome to the Sullivan Financial Planning inaugural blog. People in the know tell me that blogs should be short, entertaining, and informative. Easier said than done when talking about personal finance. At least the entertaining part.
As far as informative goes, I’m starting with a series about using Traditional IRAs or Roth IRAs. This first blog is going to explain the difference between the two. Then, I’ll spend the next few weeks describing reasons why people choose to use one over the other.
In the beginning, there was darkness…and pensions and Social Security for retirement. Then, in the early 1970s, Congress got the bright idea to encourage people to save for their own retirement. Thus was born the Individual Retirement Account, or IRA.
At first, people were able to put up to $2,000/year into an IRA and take a tax deduction for that amount. Then, the growth was allowed to stay in the IRA with no taxes on the dividends, interest, or capital gains until you withdrew the money at retirement (starting at age 59 ½).
Here’s a fun fact: When IRAs first started, a person working outside the home could put in up to $2,000/year in their retirement account. How much could the stay-at-home spouse put in? A whopping $250. How’s that for your government discounting your efforts at home? Now, though, a non-working spouse can contribute as much as a working spouse.
But, pretty soon, the IRS came knocking on Congress’s door saying, “Helloooo? We miss our tax revenue!” So, the ability to take that nice tax deduction on your IRA contribution started to be whittled away.
First, the rules were changed to disallow tax deductions for your IRA contributions if you made over a certain income (and it wasn’t real high). Then, when 401(k) plans came along in the early 1980s, we were told that if we had the option to participate in a 401(k), we couldn’t take a deduction for our $2,000 IRA contribution.
Now, as Americans, we are nothing if not motivated by immediate gratification. So, if the tax deduction for IRA contributions is lost to most of us, will we continue to put money into the IRAs? No! We’ll by consumer electronics instead!
So, in 1997, to kick start retirement savings again, a Senator from Delaware named William Roth included the Roth IRA provision in the Taxpayer Relief Act of 1997. Modest of him to name the account after himself, wasn’t it?
The Roth IRA rules said that you can put in up to $2,000 to your Roth Individual Retirement Account and NO ONE qualifies for a tax deduction on the initial contribution. But the growth on the account is NEVER taxed as long as you have the account for 5 years or until you are 59 ½ (whichever is longer). By the way, the new IRA limits are higher, but more on those details in a later blog.
Because to most retirees, taxes are just another unwanted bill, the idea of having a pool of tax-free money to withdraw is pretty nice. And so, a new era of choice (and confusion) in retirement savings began.
Next blog, I’ll go over some of the reasons people use Roth vs. Traditional IRAs and some more specific rules for both accounts.
See you next week!
Kristi
