Americans are living longer, but they are not saving enough to ensure a secure retirement. In 1997, Congress enacted new laws expanding eligibility for participation in IRAs; establishing Roth IRAs; and enhancing the spousal IRA. Although these are important, successful first steps, Congress needs to do more to give Americans a meaningful opportunity to save for retirement.

Personal savings are a critical component of a financially secure retirement. IRAs have proven to be the most effective incentive for promoting personal savings. To a significant extent, however, the effectiveness of IRAs as a savings promoter is being undermined by the complex income-based eligibility limits that apply to IRAs.

Before the 1986 Tax Reform Act, the IRA was available to all Americans with earned income. Today, eligibility for the IRAs, Roth IRAs and spousal IRAs can be determined only after the taxpayer works through a maze of eligibility requirements that include a variety of income limitations. Which of the various income limits applies depends, in part, on the type of IRA the individual wishes to establish and whether the individual (or the individual’s spouse) actively participates in certain types of employment-based retirement plans. The illustration highlights some of the steps a couple must consider before setting up an IRA.

The current income caps on IRAs are counterproductive. Those income limits preclude many middle income Americans from making deductible IRA contributions and impose a sizeable marriage penalty in certain cases. Moreover, the complexity of those rules is driving away many of those who are eligible.

Before the 1986 Tax Reform Act, IRAs were available to all Americans. Although the intention may have been to take the IRA away from more affluent households, the end result of the 1986 Act income limits was to drive over seven million Americans with income below $50,000 out of IRAs. In fact, IRA contributions dropped by more than 40% for those who continued to be eligible for deductible IRAs in the year after income limits were imposed, and participation by those with income under $50,000 has since dropped by over 65%.

Current Income Limits Exclude Many Middle Income Americans

Even with the improvements that were made in the 1997 legislation, many middle income Americans (those individuals with income above $31,000 and couples with income above $51,000) are still not eligible for fully deductible IRAs.

For some couples, the current income limits also impose a severe marriage penalty. For example, two individuals with $30,000 of income are each allowed to deduct $2,000 of IRA contributions today ($4,000 total). If they marry, their IRA deductions will be reduced to $200 each -- an increase of $1,000 in their Federal income taxes that results directly from the IRA income limits.

Limits Reduce Savings by All Americans

To the wealthy, the relatively small IRA tax advantage has a negligible impact on overall taxes. In the end, the IRA income limits hurt those who are stuck in the middle -- Americans who may not have tax planners and accountants. Those families will not lock money into an IRA unless they are sure they understand the rules. Some of these people will delay contributions to make sure they will qualify and then later forget to make the contribution, or spend the money in the meantime. Others may qualify for a full or partial IRA this year, but still will not contribute because they assume they won’t qualify in the future or because the contribution permitted is too small.

Annual Income Limits Are Unfair to Taxpayers With Fluctuating Income

For many people, income fluctuates from year to year. A universally available IRA ensures that these individuals can make IRA contributions in the good years -- the years in which they have the financial resources to make a contribution. This is particularly important for the self-employed and for individuals in cyclical industries like farming. Similarly, women who left the paid workforce for a period of time to raise children could save more through an IRA during the years after their children are grown.