The IRA at 40: Has It Lived Up to Its Promise?
The 2015 version of the retirement account doesn't look much like 1974's
Let’s go back in time to 1974…Nixon resigned, the Dow ended the year at 616, Kojak was on, The Exorcist spooked moviegoers, pocket calculators began selling, the average cost of a new house was $34,900 and the Individual Retirement Account (IRA) was born.
Now that the IRA has turned 40 and 43 million Americans have one or more of them, it seems an apt time to review how this account has done helping Americans retire.
After speaking with noted retirement-savings analysts and financial advisers, my conclusion: The IRA has become a huge retirement vehicle, but the IRA of 2015 bears nearly no resemblance to the 1974 version.
How IRAs Have Transformed
When IRAs began, they were quaint places nearly everyone could salt away a little money every year. Now, they’re largely IRA rollovers — parking places where diligent 401(k) savers move their employer-sponsored accounts when they leave their firms and keep the cash until they make withdrawals in retirement.
Today, only 18 percent of workers who aren’t offered 401(k)-type plans save for retirement outside of work in an IRA, says Catherine Collinson, President of Transamerica Center for Retirement Studies.
“Over the last 40 years, the role of IRAs has changed dramatically,” says Alicia H. Munnell, director of the Center for Retirement Research at Boston College and co-author of Falling Short: The Coming Retirement Crisis and What to Do About It.) Since they’re now largely IRA rollover plans, Munnell says, “IRAs now hold more money than either defined benefit [pension] or 401(k) plans.”
According to the Federal Reserve, in 2014 there were $3.1 trillion in pensions, $5.3 trillion in 401(k)-type plans and $7.2 trillion in IRAs (mostly rollovers). In 1981, says Craig Copeland, Senior Research Associate at the Employee Benefit Research Institute, there were “just” $4 billion in IRAs.
It’s as if the snug VW Beetle of yesteryear morphed into today’s luxury SUV — and lost some protection for its owners along the way.
(MORE: IRA Rollovers: How Not to Get Fleeced)
“You don’t see a lot of people depending on IRAs with their own contributions these days,” says Copeland. “IRAs have become a bridge from the employer plan to retirement. That’s not how they were envisioned, but that’s what they’ve become.”
IRAs: Then and Now
A brief history of IRA time (with assistance from Munnell):
When IRAs were introduced in 1974, they were only available to workers who weren’t covered by employer-sponsored retirement plans. The maximum annual contribution was $1,500 — keep in mind that 401(k)s didn’t come along until the 1980s, so IRAs were pretty much the only retirement-savings game in town.
The IRA floodgates opened in 1981, when a new tax law let anyone under 70 ½ contribute to them (it also boosted the maximum annual contribution to $2,000).
I worked at Money at the time and remember these changes as a BIG DEAL: I came up with the idea for a special newsstand-only IRAs one-shot magazine explaining how IRAs worked and how to invest in them; we published it in 1983. Banks and brokerage firms were going nuts — it was their financial fanfare for the common man — promoting the accounts on TV, radio and in print. Savers’ money flowed in, albeit in small, steady streams.
The Tax Reform Act of 1986 threw cold water on IRAs, marking the beginning of the end of IRAs as we knew them. It phased out the deduction for IRA contributions among higher-income workers who were covered by employer-sponsored plans.
Since then, you probably haven’t seen much promotion for IRAs — aside, perhaps, from brokerage and mutual fund come-ons to attract your IRA rollover money. “They go where the money is,” says Dave Richmond, a founding partner for the financial advisory firm Richmond Brothers in Jackson, Mich.
The biggest IRA law changes in the past 20 years: Nondeductible Roth IRAs (a 1997 law) whose retirement withdrawals are generally tax-free. And IRA annual contribution limits have grown a bit, to $5,500 in 2015; $6,500 for people 50 and older.
(MORE: 9 Changes That Will Affect Your Money in 2015)
Assessing IRAs at 40
“Having the IRA has been a huge win for consumers,” says Richmond. He particularly likes IRAs as estate-planning instruments, because you can name contingent beneficiaries and stretch out withdrawals to your heirs when they retire.
But some retirement analysts think the byzantine rules for IRA contributions, deductions and withdrawals have turned a simple way to help Americans save into a confusing mess.
Says Collinson: “This simplistic savings vehicle has become quite complicated,” adding that “such complexity can be counter-productive and a deterrent to saving.”
The complexity, compounded with the after effects of the last recession and the growth of IRA rollovers explains why just 6.1 percent of those with family incomes under $10,000 have IRAs or Keoghs while roughly 59 percent of those with incomes of $100,000 or more do, according to the Employee Benefit Research Institute.
“Almost all the rules having to do with IRAs need to be simplified,” says Richmond. “The whole tax law needs to be simplified.”
The Trouble with IRA Rollovers
IRA rollovers haven’t been entirely wonderful for retirement savers, either.
A 2013 Government Accounting Office (GAO) study found that 401(k) participants often get guidance and marketing favoring IRAs when looking for help on what to do with their plan savings as they leave their firms — often to their detriment.
The GAO discovered, for instance, that the IRA rollovers often charge higher fees than what people would pay if they kept their money in their 401(k) plans. “We found that a lot of money steered towards IRA rollovers might not be the most appropriate option for individuals,” says Charles Jeszeck, the GAO’s director of education, workforce and income security issues.
Munnell notes that IRA rollovers, unlike pensions and 401(k)s aren’t protected by fiduciaries. Also, “unlike sponsors of 401(k) plans, [rollover] IRA providers are not required to provide any information on fees.” To Munnell, “an arrangement designed to fill in the cracks in our retirement system has become the major retirement saving vehicle — while remaining relatively unregulated.”
The Future of IRAs
What does the future hold for IRAs?
- IRA rollovers will likely grow enormously as increasing numbers of boomers transfer their 401(k) money into them when they prepare to retire — roughly 10,000 boomers turn 65 every day.
- The Obama administration’s MyRA plan (rhymes with IRA) will begin in earnest this year, echoing the original IRA of 1974. MyRAs will be nondeductible Roth IRAs for people whose employers don’t offer retirement plans and will be limited to individuals with income below $129,000 and couples with incomes under $151,000.
- Some states are developing their own versions of automatic IRAs for residents lacking access to employer-sponsored retirement plans. For instance, the Illinois Secure Choice Savings Program is due to begin rolling out in 2017.
Happy 40 IRA: My how you’ve changed!