U of Ideas of General Interest -- March 2000
University of Illinois at Urbana-Champaign
Contact: Mark Reutter, Business & Law Editor, (217) 333-0568; [email protected]
RETIREMENT SAVINGS
IRA changes that let people withdraw early jeopardize their future
CHAMPAIGN, Ill. -- Twenty-five years ago, Congress created the IRA (Individual Retirement Account) to encourage Americans to set aside a portion of their yearly income in a special tax-deferred account for retirement.
But in recent years Congress has passed several tax exceptions that encourage people to "raid their IRAs" for immediate expenses that jeopardize the very savings the IRA was meant to promote, according to a University of Illinois tax expert who has conducted an in-depth analysis.
"It is time to get back to first principles," Richard L. Kaplan, a UI law professor, wrote in the current issue of the Elder Law Journal. The changes go against the original intent of the law and create "inappropriate temptations" to use retirement money for immediate consumption.
The original law imposed a 10 percent penalty on withdrawals made before the IRA holder was 59-1/2 years old. As a result, tapping an IRA for pre-retirement expenditures was an expensive source of funds.
Since then, Congress has waived the 10 percent penalty for certain activities. Kaplan is especially critical of the rule permitting the withdrawal of up to $10,000 in IRA funds to buy a home. According to a sample calculation, a 35-year-old who takes $10,000 out of an IRA account to buy a house will lose nearly $200,000 in eventual retirement funds -- "truly a case of short-term gain offset by long-term pain."
Similarly, withdrawing IRA funds to pay for college tuition is a poor investment strategy. "With all the education-specific tax incentives already in place, educational costs hardly seem to warrant an IRA penalty exception, particularly one that might jeopardize an IRA holder's retirement security," Kaplan wrote.
A final exception to the 10 percent penalty applies to medical expenses. This provision was passed by Congress in 1996 in the wake of the failure of Congress to pass the Clinton administration's universal health care program.
"Encouraging people to raid their IRAs to deal with the problem of uninsured Americans is an inadequate approach to the societal dilemma of Americans who are not covered by health insurance plans," he said. Kaplan recommended that Congress repeal the recently enacted provisions before "they harm prospective retirees," especially in light of the historic low levels of savings now found in American households.
Kaplan's article is titled "Retirement Funding and the Curious Evolution of Individual Retirement Accounts." The Elder Law Journal is published by the UI College of Law.
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