Traditional and Roth Individual Retirement Accounts (IRAs): A Primer

"In response to concerns over the adequacy of retirement savings, Congress has created incentives to encourage individuals to save for retirement through a variety of retirement plans. Some retirement plans are employer-sponsored, such as 401(k) plans, and others are established by individual employees, such as Individual Retirement Accounts (IRAs).

This report describes the primary features of two common retirement savings accounts that are available to workers for independently saving a portion of their wages or to individuals rolling over savings from employer-sponsored plans—traditional IRAs and Roth IRAs. Individuals may roll over eligible distributions from other retirement accounts (such as an account balance from a 401(k) plan upon leaving an employer) into IRAs. Rollovers preserve retirement savings by allowing investment earnings on the funds in the retirement accounts to accrue on a tax-deferred basis, in the case of traditional IRAs, or a tax-free basis, in the case of Roth IRAs. Most inflows to Roth IRAs are from contributions; in contrast, most inflows to traditional IRAs are from rollovers.

Both traditional and Roth IRAs offer tax incentives to encourage individuals to save for retirement. Although the accounts have many features in common, they differ in some important aspects, such as deductibility, eligibility to contribute, and tax treatment. Contributions to traditional IRAs may be tax deductible for taxpayers who (1) are not covered by a retirement plan at their place of employment or (2) have income below specified limits. Contributions to Roth IRAs are not tax deductible and eligibility is limited to those with incomes under specified limits.

The tax treatment of distributions from traditional and Roth IRAs differs. Distributions from traditional IRAs are generally included in taxable income, whereas qualified distributions from Roth IRAs are not included in taxable income. Some distributions from both may be subject to an additional 10% tax penalty, unless the distribution (1) is for a reason specified in the Internal Revenue Code (e.g., distributions from IRAs after the individual is aged 59½ or older are not subject to the early withdrawal penalty) or (2) meets a temporary exception in response to certain disasters.

This report explains IRAs’ eligibility requirements, contribution limits, tax deductibility of contributions, and withdrawal rules, and it provides data on the accounts’ holdings. It also describes the Retirement Savings Contribution Credit (also known as the Saver’s Credit), which is a nonrefundable tax credit of up to $1,000 ($2,000 if married filing jointly) available to individuals with income under specified limits who make IRA (or other retirement plan) contributions. Lastly, it explains provisions enacted after certain federally declared disasters, starting with the Gulf of Mexico hurricanes in 2005, that exempt distributions to qualified individuals from the 10% early withdrawal penalty.."
IRA and Roth Accounts 

Individual Retirement Account (IRA) Ownership: Data and Policy Issues

"Retirement income in the U.S. can come from multiple sources—Social Security, savings in employer-sponsored plans (e.g., public and private defined benefit plans and defined contribution plans), and private savings (e.g., annuities, other investments, individual retirement accounts [IRAs]). This report focuses on IRAs, which are tax-advantaged accounts for individuals to save for retirement.In 2019, about 25% of U.S. households owned IRAs.
 

 IRAs were first authorized by the Employee Retirement Income Security Act of 1974 (ERISA; P.L. 93-406) for two reasons: (1) to encourage workers without access to employer-sponsored plans to save for retirement and (2) to allow workers with employer plans to roll over their savings and retain tax advantages. Though eligibility was originally limited to workers without pension coverage, subsequent legislation expanded eligibility to nearly all workers. In 1997, Congress authorized a new type of IRA—the Roth IRA.
 

 Traditional and Roth IRAs differ based on their tax treatment. Contributions to traditional IRAs may be deductible from taxable income while withdrawals are included in taxable income. Contributions to Roth IRAs are not deductible, but qualified withdrawals are not included in taxable income; investment earnings grow tax free.
 

 IRAs are funded by contributions and rollovers. Contributions are subject to an annual limit. In 2020, this limit is $6,000 ($7,000 for individuals ages 50 and over). A rollover occurs when assets are transferred from one retirement plan,such as an employer-sponsored401(k), to another. Rollovers are not subject to the contribution limit. Most inflows to traditional IRAs are from rollovers, while most inflows to Roth IRAs are from contributions

Individuals with IRAs can choose their investments based on options provided by their financial institutions. Contributions, rollovers, and any investment earnings can be used as a source of income in retirement. To discourage IRA owners from withdrawing funds prior to retirement, the Internal Revenue Code imposes a 10% penalty on most early withdrawals, with several exceptions outlined in Title 26, Section 72(t), of the United States Code. Aside from these exceptions, Congress has temporarily exempted early IRA withdrawals from the penalty following certain past events, including multiple natural disasters and,most recently, the Coronavirus Disease 2019 (COVID-19) pandemic..."
Individual Retirement Account