I'm back for another week of Ashley Asks A Question. If you're an avid follower of my super insightful (read totally confused) questions you might have noticed I didn't post one last week. That's because we focused the entire week on financial New Year's Resolutions. While editing the post on Retirement I learned the contribution limit on IRAs was considerably lower than those placed on 401(k)s. How can this be, I asked myself. What is the meaning of this I shouted! So I did what I always do; turned to Wela COO Eddie Goepp, CFP® for answers.
PS if you didn't read the resolutions series you need to get up on that ASAP. There's even a killer worksheet in post number 1 to help you figure out where to start.
Let's get to it.
Why is the limit on IRA contributions so much lower than the limit on 401(k) contributions?
This is a great question and unfortunately the answer leaves much to be desired. The limits that were put in place were set by Congress and are adjusted every few years to keep up with inflation. That’s why you saw the IRA contribution limit go from $5,000 in 2012 to $5,500 in 2013. It’s stayed at that level through 2016. The very first limit was the lesser of $1,500 or 15% of household income.
The 401(k) (which refers to the section of the tax code which allows for these plans) was set up to help highly compensated employees defer income tax and supplement their retirement savings. The 401(k) has now grown to the most widely used vehicle for retirement savings. Currently the 401(k) contribution limits are $18,000 for age 49 and under; and $24,000 for 50+.
Considering the fact that not all companies offer these types of savings vehicles, the Individual Retirement Arrangement (IRA) was implemented in 1974. The two primary goals of the IRA were to provide a tax-advantaged retirement plan to employees of businesses that could not provide a pension plan; as well as to provide employees a vehicle for preserving tax-deferred status of retirement assets when they leave their employer (e.g. rollovers).
I could certainly speculate as to why these contribution limits are so different but I'm going to save my political commentary for more appropriate spaces like cocktail parties or networking events (jk). The fact, albeit probably not what you wanted to hear, is: because Congress said so.
Bottom line: While it's something that makes many of us shrug our shoulders at, there is no real answer. Even as adults we're still getting the response "Because I said so." So just follow the rules people.