Julie Jason: Who is contributing to Roth IRAs?
Who is contributing to Roth IRAs, the tax-free (as opposed to tax-deferred) individual retirement accounts?
This may come as a surprise. According to Employee Benefit Research Institute (EBRI), it's younger investors by a wide margin.
About 43 percent of Roth owners ages 25-29 contributed to Roth IRAs during 2012, compared with only 21 percent of Roth owners ages 60-64.
Forty-four percent of those between the ages of 25 and 29 contributed the maximum permitted by law ($5,500).
The average Roth balance for the 25-29 age band was $12,427. With increased age, average balances increased. For example, the average Roth balance for those age 70 and up was $79,442. For all ages, the average was $31,288.
What's more, six times as many 25- to 29-year-olds contributed to a Roth (151,000) in 2012 than to a traditional IRA (25,000). The average amount contributed to Roth IRAs by this age group was $3,252, compared with $2,760 to traditional IRAs.
This cohort has figured out that there is no smarter way to save for the long term. The reason? No taxes.
When you make an investment on your own in a taxable account, taxes are due on earnings and gains. That cuts into returns, especially if you have a long horizon, as a young investor would.
If you invest through a traditional IRA, you are not taxed until you want to or have to take your money out. Starting after age 70Â½, a certain amount must be withdrawn each year for the rest of your life and beyond, by your beneficiaries.
With a Roth IRA, you as the Roth IRA owner pay no income taxes at all (after a five-year holding period). Plus, you are not forced to withdraw money at any time, in contrast to the traditional IRA's post-70Â½ mandatory withdrawals. Beneficiaries who inherit your Roth are required to withdraw a certain amount each year, but no income taxes are due on those withdrawals.
Vanguard, a mutual-fund company, provides an illustration of the difference in tax consequences for a 34-year investment horizon for someone in the 28 percent tax bracket. Over that period of time, assume the investor would have invested a total of $170,000 ($5,000 a year for 34 years) in an S&P 500 Index Fund that grew to $1.3 million. That value would be fully available to him without being reduced by taxes. The traditional IRA, after taxes, would be worth about $300,000 less, even after accounting for the tax savings ($47,800) that he would have taken advantage of at each year when he contributed to the traditional IRA.
From my perspective as a professional money manager, starting and contributing to a Roth IRA is the smartest choice for the younger investor. There is simply no other vehicle that provides the opportunity for growth completely unfettered by income taxes.
Released last month, the EBRI data is based on a nationwide review of 25.3 million IRA accounts owned by 19.9 million unique individuals with total assets of $2.09 trillion.
The EBRI report, "Individual Retirement Account Balances, Contributions, and Rollovers, 2012; With Longitudinal Results 2010-2012: The EBRI IRA Database," is published as the May 2014 EBRI Issue Brief. If you would like to have a copy, link to it at http://www.ebri.org/pdf/briefspdf/EBRI_IB_399_May14.IRAs.pdf, or email me at email@example.com.
EBRI is a private, nonpartisan, nonprofit research institute that focuses on health, savings, retirement and economic-security issues (http://www.ebri.org).
The June 12, 2014, EBRI Fast Facts issue brief, titled "Roth IRAs: Who's Contributing and How Much?" can be found at http://www.ebri.org/pdf/FF.285.Roth-IRAs.12Jun14.pdf.
For another resource on the Roth IRA investor, see the Investment Company Institute's "The IRA Investor Profile: Roth IRA Investors' Activity," released in June 2014 (http://www.ici.org).
Julie Jason, JD, LLM, a personal money manager (Jackson, Grant of Stamford, Conn.) and award-winning author, welcomes your questions/ comments (firstname.lastname@example.org).