The Roth IRA has become one of the cornerstones of American retirement planning. However, in the two decades since its inception, William Roth helped create these tax-advantaged accounts has largely faded from public memory.
A Little History
A look back at Senator William Roth Jr.’s vision for the investment vehicles helps explain their long-term popularity. By the time Congress set to work on the Taxpayer Relief Act of 1997, the Republican from Delaware was becoming concerned about the low savings rate in the U.S., compared with other developed countries such as Japan and Germany. “It is in the national interest both for the economy and the family that we have significant savings,” Roth told Gobind Daryanani, author of “Roth IRA Book: An Investor’s Guide,” in 1998.
The individual retirement account (IRA), which allowed workers to deduct contributions from their taxable income, had been around since the 1970s. But William Roth, then chairman of the Senate Finance Committee, sought a more flexible version of the IRA, one that would be particularly enticing for younger investors. He successfully lobbied to have the new Roth IRA added to the Taxpayer Relief Act.
In some ways the accounts bearing his name would be the mirror image of Traditional IRAs, in which contributions are tax deductible but withdrawals in retirement are subject to income tax. The Roth IRA offered Americans another alternative: to invest after-tax dollars but withdraw money tax free after the age of 59½. According to Daryanani’s estimates, Americans receive an added benefit of anywhere from 10 to 50 percent by postponing their tax break. Another difference would be that investors wouldn’t have to worry about required minimum distributions in their lifetime, as is the case with Traditional IRAs.
Growing in Popularity
By any measure the impact of the Roth IRA has surpassed even the lofty goals set by Senator William Roth, who died in 2003. Back in 2000, taxpayers held $77.6 billion in Roth accounts. In 2016 nearly 22 million households owned a Roth version of the IRA, with Roth assets totaling roughly $660 billion.
Originally, American taxpayers were only allowed to contribute up to $2,000 of their after-tax earned income to a Roth IRA, and there was no catch-up contribution for citizens who were 50 and over. It took a number of years for the contribution limits to increase to the current amount of $5,500 per taxpayer ($6,500 for those eligible for a catch-up contribution). In 2019, for the first time in six years, the limits are going up again to $6,000 per taxpayer, or $7,000 for people age 50 and over.
Also, originally the Roth IRA had an income limit for which taxpayers were eligible to contribute of $150,000 per year for couples and $95,000 for individual taxpayers. Today the income limits to contribute to a Roth IRA start to phase out at $189,000 for joint filers and $120,000 for singles. The income figures in 2019 are $193,000 (married joint filers) and $122,000 (single filers). And you can continue to contribute to a Roth IRA at a partial contribution level until you earn $199,000 (joint; $203,000 in 2019) and $135,000 (single; $137,000 in 2019). (Learn about all of the various Roth IRA rules.)
If Americans hoped to have enough money to meet their retirement goals, Roth believed they needed to start investing earlier in their careers. “What we are really trying to do is develop a culture of savings,” Roth told Daryanani. “We’d like people to start off when they’re young and every year save whatever they can afford.”
In an effort to attract younger individuals, Roth and his colleagues built a degree of flexibility into their version of the IRA. Thus, the law allowed early withdrawals of up to $10,000 for the purchase of a first home. Americans could also pull out funds tax and penalty free for qualified educational expenses. “As a nation, we do not want our young people getting married and starting families with the burden of a huge debt,” Roth explained.
The accounts offered a number of key features for older investors, too, such as the ability to leave investment funds to one’s children or to another beneficiary. There are no tax implications when Roth IRAs are transferred to a spouse at death, and non-spousal beneficiaries have options on how to disburse a Roth IRA that is bequeathed to them. A Roth IRA can be used to avoid estate tax as well. With those added benefits built in, Roth hoped more investors would feel comfortable setting aside part of their income for retirement.
While many Americans still struggle to save at the level they need to, the number of individuals who have decided to start a Roth IRA suggests that the country is moving closer to the senator’s vision. Roth said, “If you work hard and save hard, you can have a good retirement income that allows you to leave something to your children.”
Like most Americans and other citizens around the world, parents want to provide their children with a better life than the one they had. The Roth IRA has become one of the primary tools to do just that.