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IRAs Fall Short of Original Goal

Nearly 8 trillion dollars sits in Individual Retirement Accounts, or IRAs. This is nearly half of all the value held in the U.S. retirement system, which also includes employer pension funds and 401(k)s.

A big reason IRAs were created in 1974 under the Employer Retirement Income Security Act (ERISA) was to give individuals not covered by retirement plans at work an opportunity to save in their own tax-deferred accounts.

So, are IRAs helping these workers?

IRAs “have drifted very far from their original intent” of helping those who need them most, researchers for the Center for Retirement Research conclude in a new study.

Who is eligible to receive tax benefits for saving in an IRA has morphed over the years since ERISA’s passage, but the original description is still relevant to millions of Americans: about half of U.S. private-sector workers today do not have a tax-exempt retirement plan at work.  Low-income workers are even less likely to have one.

To determine who benefits from IRAs today, the researchers first tracked down the source of the trillions of dollars held in IRAs.  Only 13 percent of the money that flowed into IRAs in 2014 was from people putting new savings into these accounts.  The rest was from rollovers of funds accumulated in employer 401(k)s, which usually occur when a worker retires or changes job.  (ERISA did delineate rollovers as a second purpose of IRAs.)

So what types of people are contributing new money?  This is the critical question, because it became clear after ERISA’s enactment that IRAs had quickly become a popular tax shelter for high-income taxpayers.  In 1986, Congress tried to limit this use by capping or eliminating tax-deductible contributions to IRAs among workers who already have a retirement plan at work and have earnings above specified income limits.  In 1997, a new type of IRA was created, the Roth IRA; Roths also have income limits, which are the same regardless of whether or not one’s employer offers a retirement plan.

The researchers found that active contributors today to IRAs – both traditional IRAs and Roths – have household earnings that average $110,000.  They also tend to be white (86 percent of contributors), have a college education (61 percent), and participate in their employer’s 401(k) (53 percent).

A second analysis sharpens the profile.

One group of IRA contributors is “super savers,” which are households with two workers earning fairly high combined incomes (nearly $150,000 per year, on average) who are also saving money in their employer 401(k)s.  A second group, called “frugal breadwinners,” consists of middle-income individuals or middle-income households in which one person works – the majority of them also contribute to a 401(k).  The third group is made up of successful, self-employed entrepreneurs who apparently use IRAs as their primary retirement savings account – their average incomes exceed $140,000.

The people saving new money in their IRAs – a minority of all IRA owners – are not primarily the people these accounts were designed to serve.

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28 Responses to IRAs Fall Short of Original Goal

  1. CE BURKE says:

    “Nearly 8 trillion dollars sits in Individual Retirement Accounts, or IRAs. This is nearly half of all the value held in the U.S. retirement system, which also includes employer pension funds and 401(k)s.”

    Does this mean the government will confiscate our IRA’s since they are broke? Does it also mean our USD’s will be reset to represent nothing of value?

  2. Donald Mayfield says:

    I read recently that IRA stands for Individual Retirement Arrangement. Is this correct?

  3. Howard Jaquay says:

    This article seems to imply that those people who have achieved high incomes should not have the opportunity to save for their retirement. In reality, high income earners in no way prevent lower income earners from saving for retirement. Programs such as the Earned Income Tax Credits, MyRA, and such do provide some incentive for retirement savings for lower income people. These programs do not, however, change the mind set of those who do not choose to save.

    • Ken Pidcock says:

      The question is who gets to defer tax on income, not who gets the opportunity to save for their retirement.

  4. Joe Gordon says:

    The only IRA failure was Congress limiting contributions by caps and deductibly by income phase-outs. In essence, they allowed low income earners, with zero excess cash, have free reign and everyone else got the shaft!

  5. Paul Brustowicz says:

    Saving for retirement is a great idea, however, as pointed out, the folks who should be doing it aren’t. Why not? They are not educated on the value of saving in a tax-deferred account.

    Saving for retirement is like buying life insurance or disability insurance, workers need to be sold on the idea of protecting themselves against the risk of living beyond age 67 without a job and a source of income other than Social Security.

    As stated in other places in this blog, financial education is the key to improving the retirement fortunes of all classes of workers.

    • Dave says:

      Who do you suggest be responsible for educating citizens about the need to spend less than they earn and invest for their retirement? Wall Street? Stock brokers? Mutual fund registered reps? Insurance agents? Be careful what you ask for.

      Or should this responsibility be thrust upon school teachers?

      Please enlighten.

  6. Brian says:

    ‪48% of my IRA balance is IRA deposits + growth; 52% is 401K & pension lump sum direct rollover.‬ My wife’s account –> 11% IRA deposits + growth; 89% is 401K & pension lump sum direct rollover.

    Over the decades, we simply max’d out any opportunity for federal/state tax avoidance and savings/investment that the government made available to us. There was no concern as to whether we were the intended targets – just wanted to keep as much of our hard-earned money as possible. (From the description in the above article, apparently we were not the intended targets.) And being Black, with a masters degree, and a high-earning spouse, I certainly broke the other demographic mentioned in the article.

    Now in retirement, we look for every opportunity for federal/state tax avoidance as we balance withdrawals from those accounts with other non-qualified accounts we have.

    • Dave says:

      Traditional IRAs and 401(k) plans are tax deferred arrangements, not tax avoidance.

      With Roth IRAs and 401(k)s, the tax benefits are “back-loaded” – qualified distributions are income tax free.

      Often, Congress passes laws to encourage some behaviors or discourage others. Bestowing income tax benefits on IRA, qualified retirement plans, etc. were intended to encourage employers to sponsor retirement plans and encourage individuals not covered by a retirement plan to have a tax advantaged way to do so on their own via the establishment of IRA via ERISA in 1974.

      It should come as no surprise that IRAs and now 401(k) are most often used by individuals with means (i.e. those with higher incomes). The article makes this point rather plainly.

      • Brian says:

        Our joint AGIs were always too high to qualify for Roth’s. If I recall correctly, the income limits for Roth’s changed in 2010, but we had retired by then. So, our efforts were aimed at using our 401Ks/IRAs as both tax deferral and tax avoidance techniques (along with our other non-qualified savings).

        Now that we’re 7 years into retirement, we’ve been able – via tax-efficient withdrawals from our various investments (some from those IRAs) – to avoid any federal taxes so far. It’s had the additional benefit of allowing us to use the ACA marketplace for affordable health insurance (which bases its subsidy on modified AGI), which has saved us many thousands of dollars so far. Certainly, Congress had their intended goal – if others can make use of those laws, that’s a personal choice.

        We realize that as slowly as we’re depleting our IRA balances that this (tax avoidance) can’t last forever. Once we’re Medicare age, we can convert some of the IRAs to Roths, later (in our 70s) making charitable contributions from our IRAs (to help satisfy RMD requirements), and as much as is possible, avoid taxes on what we can, and (as you well point out) defer taxes on the rest (albeit at a much reduced tax rate from what we were paying during our working years – which is still a means of tax avoidance).

        It’s an interesting game. Just need to know the rules (i.e., laws).

  7. Joel Margolis says:

    I have a suggestion for an alternative approach.

    The federal government should mandate savings. All Americans below the age of 70 with income (earned or unearned) would be required each year to set aside 10 percent of their gross income for retirement. The money would be collected via withholding, with individuals filing estimated “savings,” for that part of their income that is not subject to withholding. The money would be invested in mutual funds that index the world stock, bond, and real estate markets. The funds would be run by companies that would bid for the right to invest. There would be a five or seven person board, nominated by the President and confirmed by the Senate, that would oversee the operations.

    Money invested would be tax free going in and taxable going out. The funds, unlike Social Security, would be owned by the investor. At age 70 the individual could start withdrawing the funds. The cost of the program would be paid for by eliminating tax benefits for all other retirement plans (e.g., IRAs, 401ks, SEPS, etc.). Monies in those plans would remain in them and subject to the rules under which they were created but no additional funds could be placed in such accounts. The current retirement system benefits two types of individuals: (1) affluent Americans and (2) those with high savings rates.

    The former already get enough tax breaks and the latter will save no matter what. The people who truly need retirement savings are the ones least likely to participate.

    Obviously this plan would be a generational one. Its benefits would not really be felt for many decades to come but eventually it would put all Americans on a path to prosperity.

    • Mike says:

      There is such a program. It’s called Social Security.

      • Phyllis Cook says:

        Exactly!

        • Dave says:

          The plan Joel suggests is not Social Security. There are payroll taxes to fund Social Security paid by employees and employers. But those dollars aren’t invested, they are used to pay current benefits out. For the past couple years, payroll taxes paid have been less than benefits paid out, the difference has been made up via interest on the non-negotiable bonds held in the Social Security Trust fund. The Social Security Trust fund will, in a decade or so, be totally exhausted (interest paid and bonds matured via money from the federal budget which has about $20 trillion of debt).

          I don’t want the federal or state governments managing money either. And I don’t want Wall Street to get their mitts on the money. I think the Feds should provide a very simple infrastructure for a national default retirement income plan. Two investments: one a world stock-bond index, the other a savings account both run by a government computer. Super low fees. People can opt out if they want. Nothing mandatory. And I’d be fine letting people invest the money anywhere they want however they want.

          Federal law right now around qualified retirement plans is ridiculously complex. A simple national IRA plan would be an alternative to what exists now.

          It’ll never happen. But the current environment for retirement planning is broke.

    • Phyllis Cook says:

      Okay, seriously?! Let’s first start with mandating that employers pay a living wage to keep up with COL increases/inflation and cap CEO salaries and benefits, same goes for Congress. Then people can afford to save 10% of their income! When you’re making $10 an hour and your rent is $1,200 how you gonna save for retirement! Just saying!

    • Phyllis Cook says:

      The other problem with that is the real estate bust in 2008, which personally crashed 40% of my IRA! It has yet to break even let alone earn anything. You can’t force people into Wall Street gambling where the big players make and change the rules to suit themselves. They gamble with our money and want a bailout when they lose! Those people should be in jail. Instead, they’re still gambling and getting richer by the day. I don’t care to be mandated to give them one more dime of my hard-earned money!

      • Steve says:

        When your IRA tanked did you leave the money invested in growth investments such as stocks or did you move it to something safer like bonds or money market? If you left it invested it would have recovered by 2013, and would have maybe tripled from the 2008 low to today. More or less the same if it was invested in real estate; it took a while to recover but it has recovered, and then kept going. The only way you didn’t recover is if you locked in your losses by taking your money out of the game.

  8. Michael Waggoner says:

    I do not think that this article should be viewed as critical of higher-income people who use IRAs. They are entitled to the benefits the laws provide.

    The article’s points are (1) there are huge tax benefits provided to IRA owners and (2) is this the the best way to award those benefits?

    Instead of helping those without adequate retirement savings, a very serious problem, current IRA subsidies are largely going to those who need little help.

    We are running large deficits during an economic boom. Our national debt is great and growing. We need to be careful, not only in our spending and in our taxation, but also in the provision of tax benefits that add to deficits and debt. The article raises the important question, “Can we do better in the design of the IRA?” I think we can.

  9. Dan Wick says:

    A new government retirement “tax” may not be the perfect answer. I am sure the money would be held for years to compound just like SS has been. Then they could also decide who most deserves the money at a later date. The government could mandate education concerning financial well being and continue tax incentives for those that learn. Trying to make the horse drink will not work. Just get him to the water.

  10. Dave says:

    I’d strongly support the federal government simply making this sort of arrangement possible for anyone to use if they wanted to do so (rather than make it mandatory).

    And, it would make sense to have this system be “auto enroll” so that employees had to opt-out. The default contribution rate should be 10%. Employee could contribute whatever they wanted in excess of that.

    All employee contributions would be Roth (post tax). And available for whatever the employee wanted whenever they wanted.

    The default investment would be stable value type (e.g. a savings account) fund backed by the feds that guaranteed an annual rate of interest equal to 10-year Treasuries. Employees would have one other investment option for some or all of their money, a World Stock-Bond Index Fund.

    And if an employer wanted to help employees prepare for retirement, they would be free to “match” any employees with a contribution that is the same % of salary for ALL employees – part-time, full -time, etc CAPPED at $15,000.

    Employer matching contributions would not be taxable as current income to employees BUT also, would not be available FOR ANY REASON until the employee is say age 60 or is disabled or dies.

    At age 55, any employer matching funds would be transferred gradually (20% of the balance annually over five years) from the World Stock/Bond Index Fund into a Social Security Like Account that would provide a life time income, with perhaps the first $12,000 (indexed for inflation) of retirement income from this bucket income tax free. 100% of all employer matching contributions would eventually generate retirement income.

    Individuals could transfer their “Roth” funds into this retirement income account (some or all of it at any time) and all of that income would be tax free. The feds could set up tontines for retirees and get off the longevity risk entirely.

    I don’t think any mandatory savings plan would fly politically. But, I think the feds (rather than the states) should set up a “National Savings and Retirement Plan” infrastructure that totally avoids Wall Street and provides two investment choices with employees money – a World Stock-Bond Index and a Stable Value Fund with an interest rate tied to 10-Year Treasuries.

    The current “national retirement income policy” Congress has left us since ERISA in 1974 is clearly an abject failure given median 401(k) account balances at all age and participation cohorts are puny.

    Time to do something else.

  11. Eric Gray says:

    The last thing I need is to have the Federal or any government agency managing my money for me. I’ve contributed to Social Security since 1989 (and before that for summer jobs). If I’m fortunate enough to be able to withdraw any of the 100’s of thousands of dollars I contributed, it will be FAR below any rate of return I’ve generated on my own.

    Social Security has been gutted and paid deficits and broadened to provide to immigrants that NEVER contributed to it in the first place.

    Do I want people to be penniless and destitute in their later years? NO!!! Not at all. But there is a level of personal responsibility required to put away today what you’ll need tomorrow. Those that did it should not be penalized for those that did not!

    • Ken Pidcock says:

      In comparing your returns with Social Security, don’t forget to factor in the long-term disability insurance premiums.

  12. Dave G. says:

    There are several things not in the article or mentioned thus far of some importance:

    – IRAs and 401ks, though intended to supplement retirement, had the unintended consequence of becoming the sole retirement vehicle for many. They effectively eliminated the Defined Benefit plans that protected the prior generation of workers, transferring costs and risks onto employees directly.

    – Article makes no mention of big tax bills awaiting those hefty accumulations in these accounts. Many are now exposed to far bigger tax bills on funds drawn in retirement than taxes they saved in contributions. Uncle Sam eventually taxes BOTH contributions AND earnings later. The idea of “lower taxes” in retirement is myth for many who now have far fewer deductions vs. the working years, even without tax increases on the horizon.

    – Using tax-qualified plans to leave money to family is a particularly bad idea. Between state and federal income taxes alone, 30 to 40 percent of that can evaporate, even without any estate tax.

    The bottom line: Tax-deferred retirement accounts may not be as juicy as advertised.
    Uncle Sam is your silent partner and will get way more in taxes later than he gives up on the front end. Limit his take by maxing out Roth contributions, use non-qualified accounts for savings, pay off debt and don’t overlook ways cash value life insurance can be a ballast for your savings and financial security (once you’ve maxed out Roth contributions.)

  13. Somehow it seems that this post accuses high income people, that they have somehow prevented lower income people to save for retirement. This is not true!

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