The Evolution of the IRA

By Robin Holzschuh, CTFA, TEP, AEP®, ATFA, CFIRS® – Vice President & Chief Compliance Officer

How did the financial crisis of a car manufacturer contribute to the birth and evolution of Individual Retirement Arrangements?

The Studebaker Collapse

The Studebaker brothers opened a modest blacksmith and wagon shop in South Bend, Indiana. The company eventually grew into a manufacturer of electric and gasoline-powered cars. However, in 1963, the company’s U.S. production came to an end, leading to a devastating impact on its severely underfunded pension plan. Consequently, thousands of employees who had not yet reached retirement age received only a fraction, if any, of their promised payments.

Subsequent pension failures revealed the need for stronger regulations governing funding adequacy, vesting periods, and employee protection in the event of a company’s closure. The public outcry that ensued caught the attention of reform advocates and lawmakers, who worked together to create legislation aimed at safeguarding and expanding retirement options.

The Creation of the IRA

Before 1974, there were few options for individuals to save for retirement outside of employer-sponsored plans. That changed with the passage of the Employee Retirement Income Security Act (ERISA), a groundbreaking law designed to safeguard retirement security for employees.

ERISA’s primary aim was to ensure that private employers honored their retirement commitments to employees and to create new ways for Americans to save for retirement, especially those without access to an employer-sponsored plan. ERISA introduced the Individual Retirement Arrangement (IRA), which created a tax-efficient way to save for retirement independently from an employer.

Initially, eligible taxpayers could contribute up to 15% of their compensation or $1,500 annually to an IRA and claim a tax deduction. The Economic Recovery Tax Act of 1981 expanded IRA eligibility and increased maximum contributions. However, the Tax Reform Act of 1986 restricted deductible IRA contributions by limiting them to individuals who were not covered by an employer pension plan and who had an adjustable gross income between $25,000 and $35,000.

The Introduction of the Roth IRA

The Taxpayer Relief Act of 1997 substantially raised the income limits and introduced the Roth IRA. Named after its creator, Senator William Roth, the Roth IRA allowed individuals to contribute after-tax dollars today in exchange for potential tax-free withdrawals during retirement. This innovation gave Americans greater flexibility in tailoring their retirement plans to suit their financial goals.

The IRA Today

Since then, several inclusions in legislative acts have continued to help strengthen IRA protections and provide more flexibility – especially relating to Required Minimum Distributions (RMDs) and other tax rules.

Today, IRAs remain essential tools for retirement planning. According to the Investment Company Institute’s 2024 Fact Book:

• 56 million U.S. households owned an IRA at the end of 2023.
• Total IRA assets have grown to $13.6 trillion, representing about 35% of all U.S. retirement assets.
• Mutual funds make up 43% of IRA holdings.
• Rollovers from employer-sponsored plans have been a significant driver of IRA growth.
• Traditional IRAs hold $11.4 trillion, while Roth IRAs account for $1.4 trillion in assets.
• New Traditional IRAs predominantly stem from rollovers (74%), whereas Roth IRAs are mainly funded through annual contributions (77%).
• IRAs are making retirement more financially secure: 60% of Traditional IRA withdrawals are made by individuals aged 70 or older.
• The median ages are 51 for Roth IRA owners and 62 for Traditional IRA owners, reflecting the importance of rollovers at retirement for preserving tax benefits.

The IRA emerged from a financial tragedy that affected thousands of American workers, yet it has evolved into the cornerstone of financial security in retirement for millions. With more than five decades of history, the IRA provides several options for individuals to supplement their retirement savings regardless of whether they have access to an employer-sponsored plan.