NCPA - National Center for Policy Analysis

Expanded IRAs Not A Budget Buster

September 26, 2000

In July, the House voted to expand the amount taxpayers can invest in Individual Retirement Accounts (IRAs) and 401(k) retirement plans. The Republican proposal passed 401 to 25 with 181 Democrats assenting. So analysts were puzzled by the subsequent White House attack, which argued the bill would drain money from the surplus, leave too little for "key priorities" (spending) and fail to equally benefit those who pay taxes and those who do not.

However, the estimated revenue loss from enlarging IRA and 401(k) contributions is trivial - only $5 billion a year in an economy approaching $10 trillion. If the retirement savings incentives were even modestly successful, analysts argue, the resulting improvement in economic growth could easily end up enlarging the surplus in later years because of tax revenue from the additional growth.

  • The amount that people can contribute to an IRA has been frozen at $2,000 a year since 1981, when it was raised from $1,500.
  • The new bill raises the annual contribution limit for both regular and Roth IRAs to $3,000 in 2001, $4,000 in 2002 and $5,000 in 2003.
  • Persons over age 50 can begin making the $5,000 contributions in 2001, after which the limit for all IRAs rises each year based on inflation.
  • The bill also lifts the maximum 401(k) contribution in stages from $10,500 to $15,000 by 2005, with workers over 50 allowed to contribute an additional $5,000 a year.

Despite White House rhetoric, analysts say the claim that enlarged IRAs are a gift to the rich is not logical. Only singles with incomes below $30,000 or couples earning less than $50,000 will get a full tax deduction for their contributions to a traditional IRA. The tax deduction is scaled down for singles with incomes between $30,000 and $40,000 and couples with incomes between $50,000 and $60,000. Above those amounts, there is no tax deduction for IRA contributions.

Moreover, the traditional IRA is simply a way to defer taxes, not to escape them. By investing a small amount each year, the IRA saver ends up with a much larger income at retirement. That income is taxable when the money is withdrawn. Eligibility for the Roth IRA is more generous. Yet a Roth IRA contribution, made with after-tax dollars, involves no immediate tax deduction, so it can scarcely be a budget-buster over the brief 10-year period that supposedly worries the White House, analysts report.

Source: Alan Reynolds (Hudson Institute), "Should IRAs Be Expanded?" Brief Analysis No. 340, September 26, 2000, National Center for Policy Analysis.

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