Roth Celebrates Its 20th Anniversary

How Did We Get Here?  Where Are We Now?   

America doesn’t have a formal, stated, retirement policy.  Individual Retirement Account (IRA) and employer-sponsored retirement plan provisions are creatures of our income tax system.  Throughout the past 45+ years, we have seen American’s retirement savings take a back seat to federal government budget and revenue needs.  Following the Tax Cuts & Jobs Act of 2017, plan sponsors should expect tax revenues will continue to dominate retirement priorities.  

Roth History – How Did We Get Here? 
The history of Roth begins with the history of IRAs. Make no mistake, Roth was a response to the constant tension between retirement savings needs and our federal government budget and revenue needs.  

The Employee Retirement Income Security Act of 1974 Section 2002 (ERISA §2002) added Internal Revenue Code Section 219 (IRC §219) allowing for an income tax deduction for contributions to an IRA for taxable years after December 31, 1974. The maximum contribution in 1975 was 15% of compensation included in gross income or, if less, $1,500. However, no contribution was allowed if the individual was an active participant in an employer-sponsored retirement plan. Earnings on monies invested in the IRA accumulated on a tax deferred basis. Distributions were required to commence no later than the close of the taxable year in which the individual attained age 70½.  

The Economic Recovery Tax Act of 1981 Section 311 (ERTA §311) amended IRC §219, effective for taxable years after December 31, 1981, to allow for a tax deduction for a contribution to an IRA equal to the lesser of $2,000 or 100% of compensation included in gross income – regardless of whether the individual was an active participant in an employer-sponsored retirement plan. 

The Tax Reform Act of 1986 Section 1101 (TRA’86 §1101) amended IRC §219 for taxable years after December 31, 1986, to limit the tax deduction for contributions to an IRA where a worker was an  active participant in an employer-sponsored retirement plan with an income below $25,000 ($40,000 if married, filing jointly). If you were covered under an employer-sponsored retirement plan and had income above those threshold amounts, you could make a contribution on an after-tax, non-deductible basis. The result, contributions to IRAs declined 63% - from $37.8B to $14.1B!   

The Taxpayer Relief Act of 1997 Section 301 (TRA’97 §301) raised the income limits for a tax deduction to $30,000 (single) and $50,000 (married filing jointly) in 1998, with scheduled increases in subsequent years.  TRA’97 §302 introduced IRC §408A, the Roth IRA, which was first available in taxable years after December 31, 1997. No deduction is allowed for contributions to a Roth IRA. Roth eligibility was originally limited to those with earnings of less than $95,000 (single) or $150,000 (married filing jointly). Roth IRA earnings accumulate tax deferred, and are distributed tax free when distributed after the later of five years from the establishment of the Roth IRA or age 59 ½.  Unlike a traditional IRA, you can continue to contribute to a Roth IRA after reaching age 70 ½, and mandatory distribution rules do not apply before the account owner’s death.  

The Roth IRA was named after then-Senator William Roth (R-Del). Tax revenue considerations dominated Roth IRA design. Senator Roth was unable to reinstate the ERTA tax deduction because of the impact on government tax revenues during the 10-year federal budget window (1998 – 2007). Unlike tax-deductible contributions, Roth contributions have little revenue impact because:

• Roth contributions are not tax deductible, and 
• Tax free earnings on Roth monies are received after age 59 ½ - which, for most workers will generally occur outside the 10 year federal budget window.  

Where are we now?
Economic Growth and Tax Relief Reconciliation Act of 2001 Section 601 (EGTRRA §601) amended IRC §219 contribution limits to increase IRA contributions from $2,000 to $3,000 (2002 – 2004), $4,000 (2005 – 2007), $5,000 (2008) and indexed thereafter.  Catch-up contributions for workers age 50 or older were also added, initially at $500 then increased to $1,000 (but fixed at that level).  Similarly, EGTRRA §602 created “Deemed IRAs” where a plan could be amended to allow employees to make voluntary employee contributions to an IRA “sidecar” account within a tax-qualified, employer-sponsored plan. 

In 2018, the dollar amount contribution limits are:

• 401(k) or 403(b) deferrals - $18,500 
• 401(k) or 403(b) catch-up deferrals (age 50+) - $6,000 
• Individual Retirement Account - $5,500
• Individual Retirement Account catch-up (age 50+) - $1,000 

Whether in the form of an IRA or a Deemed IRA account, the income limits on who is eligible to contribute to a Roth IRA continue to apply.  In 2018, those limits are:

• Single tax filers: Modified Adjusted Gross Income of up to $120,000 (to qualify for a full contribution); $120,000–$135,000 (to be eligible for a partial contribution)
• Married joint filers: Modified Adjusted Gross Income of up to $189,000 (to qualify for a full contribution); $189,000–$199,000 (to be eligible for a partial contribution)However, even where highly paid employees have wages in excess of the income limits, they remain eligible to contribute to an after-tax IRA or Deemed IRA.  Then, within certain limits (and carefully following specific processes), they can convert those monies to a “backdoor” Roth.  

So, if you have not considered Roth features for your 401(k) or 403(b) plan or if you have considered and rejected adding Roth features, my next blog suggests you reconsider Roth now – in time to add those features later in 2018 or soon thereafter.