Roth IRAs Growing Twice as Fast as Traditional IRAs: EBRI

IRA guru Ed Slott says that 2010 tax law and ‘two-year sweetner’ sparked Roth IRA ‘surge’

“The Roth IRA removes the uncertainty of what future higher tax rates might do to retirement savings,” says Ed Slott. “The Roth IRA removes the uncertainty of what future higher tax rates might do to retirement savings,” says Ed Slott.

Roth IRA balances grew by more than double the rate of traditional IRAs from 2010 to 2012, increasing 16.6% compared with 7.9% for consistent owners of traditional IRAs, according to the Employee Benefit Research Institute.

What’s more, EBRI’s study, “Individual Retirement Account Balances, Contributions, and Rollovers, 2012; With Longitudinal Results 2010–2012: The EBRI IRA Database,” released Wednesday, found that rollovers overwhelmingly outweighed new contributions in dollar terms. While almost 2.4 million accounts received contributions, compared with the 1.3 million accounts that received rollovers in 2012, 10 times as much was added to IRAs through rollovers, compared with contributions, the study found.

Looking at individuals who maintained an IRA account over the three-year period, Washington-based EBRI found in its report that the overall average balance increased each year — from $95,431 in 2010 to $95,547 in 2011 and to $106,205 in 2012.

The increase occurred across each owner age group and IRA type, EBRI found, except for owners ages 70 or older (who must start withdrawing a minimum amount each year from traditional IRAs) and for traditional IRA owners whose balances originated as a rollover from another tax-qualified retirement plan, such as a pension or 401(k).

IRA guru Ed Slott says that EBRI’s study shows that the tax law beginning in 2010 that repealed the income restrictions on Roth IRA conversions — allowing everyone to convert their IRAs to Roth IRAs regardless of income — is contributing to the “surge” in Roth IRA balances.

The 2010 tax law “brought higher income people into the Roth conversion arena with larger IRA balances to convert. These people also had the money to pay the conversion taxes,” Slott told ThinkAdvisor. “Before 2010 you could not convert if your income exceeded $100,000. Once that rule was gone, the floodgates opened up for Roth conversions — especially large Roth conversions.”

Adding to the boost in 2010 Roth conversions, Slott says, was a “sweetner” — the so-called “two-year deal” in which “no Roth conversion income had to be reported in 2010 and you could spread that conversion income over two years (2011 and 2012).” This, he says, “effectively gave taxpayers an interest-free loan to build a tax-free savings account — all the gains in the Roth would be tax free, even before the tax was paid! That was a sweet deal, and that is a big reason for the huge bump in Roth IRA balances, especially in 2010.”

Another attractive quality of Roth IRAs is that they have no required minimum distributions like IRAs do, Slott adds, “and people like that too” because "they can keep their Roth IRA money growing tax free forever without ever being forced to withdraw it. Roth IRA converters (especially the new ones in 2010 that had the income and assets to pay the conversion tax) decided that paying the tax up front was worth the benefits and not having to worry about future higher taxes.”

Says Slott: “The Roth IRA removes the uncertainty of what future higher tax rates might do to retirement savings.”

As to EBRI’s finding that rollover amounts exceeded contributions, Slott says “that makes sense since IRA contributions are limited by law to $5,500 per year ($6,500 if 50 or over), but rollovers are unlimited.”

Roth conversions are rollovers, he adds, “as opposed to Roth contributions, which are subject to the annual limits.”

Another reason rollovers increased: Demographics — baby boomers [are] leaving jobs, retiring and rolling their 401(k) balances to IRAs. These are generally large balances,” Slott says.

EBRI also found that Roth IRA balances grew faster than traditional IRAs at each age group and for each gender. Younger Roth IRA owners were much more likely to contribute to the Roth IRA than were older Roth IRA owners: 43% of Roth owners ages 25 to 29 contributed to their Roth in 2012, compared with 21% of Roth owners ages 60 to 64.

“Young people are getting the message that Roth IRAs are way better for younger workers because they have the time to build substantial tax-free retirement funds using Roth IRAs (and Roth 401(k)s) as opposed to tax-deferred IRAs and 401(k)s,” Slott says the EBRI study findings show.

Younger workers, he adds, “give up an up-front tax deduction which costs them little since they are likely in lower tax brackets, and then they are exponentially rewarded with a tax-free retirement.”

Roth IRAs, Slott says, “are a no-brainer for younger workers and the new [EBRI] study confirms that — and it confirms that they are getting the message. That’s good news.”

EBRI says that its IRA database is unique in that it tracks individual IRA owners with more than one account across multiple providers, “thereby offering a more accurate and comprehensive measure of how much these individuals have accumulated in IRAs.”

For year-end 2012, it contained information on 25.3 million accounts owned by 19.9 million unique individuals, representing total assets of $2.09 trillion.

Craig Copeland, senior research associate at EBRI and author of the report, noted in releasing the report the value of being able to track IRAs over time, which the EBRI database does, as opposed to a simple point-in-time “snapshot.”

“An annual snapshot of those contributing to IRAs doesn’t allow you to assess whether the same individuals were contributing on a regular basis, or if different people contributed in different years, whereas a consistent longitudinal sample of IRA owners does allow for this examination,” Copeland said.

For example, he said that among traditional IRA owners, approximately 6% contributed to the IRA each year, but over a three-year period approximately 10% of traditional IRA owners contributed in at least one of those years. Among Roth IRA owners, approximately 25% contributed in any one year, compared with 35% who contributed at some point over the three-year period.

Other major findings of the EBRI IRA study include:

  • The overall average IRA account balance in 2012 was $81,660, while the average IRA individual balance (all accounts from the same person combined) was $105,001. Overall, the cumulative IRA average balance was 29% larger than the unique account balance.
  • The average individual IRA balance increased with age for owners ages 25 or older, from $11,009 for those ages 25–29 to $192,961 for those ages 70 or older.
  • IRA owners were more likely to be male. In particular, those with an IRA originally opened by a rollover, or a SEP/SIMPLE IRA were more likely to be male (57.4% of the former, and 58.2% of the latter).
  • Men had higher individual average and median balances than women: $139,467 and $36,949 for men, respectively, compared with $81,700 and $25,969 for women. However, the likelihood of contributing to an IRA did not significantly differ by gender within the database.

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