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Most Roth IRAs born through contributions, not rollovers

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Contributions appear to be the leading funding source for Roth individual retirement accounts, according to a new Investment Company Institute report.

In 2012, more than seven in 10 new Roth IRAs were opened exclusively with contributions — in sharp contrast to traditional IRAs, which largely are created through rollovers from employer-sponsored retirement plans. 

The report, “The IRA Investor Profile: Roth IRA Investors’ Activity, 2007–2012,” released Monday, examines a slew of variables on Roth IRAs, including contributions, tax rule changes, withdrawals, investor age and equity holdings. The report is based on the IRA Investor Database, a joint project by ICI and the Securities Industry and Financial Markets Association, and it looks at two populations of Roth IRA investors: 2.5 million “consistent” Roth IRA investors, who had accounts in every year between 2007 and 2012; and a snapshot of 5.1 million Roth IRA investors at year-end 2012.

“The use of Roth IRAs has grown significantly since their introduction in the late 1990s, and they have become an important tool for Americans to save for retirement,” said Sarah Holden, ICI senior director of retirement and investor research, in a statement.

First available in 1998, Roth IRAs had accumulated more than $400 billion in assets by year-end 2012 and exceeded $500 billion at year-end 2013.

Roth IRAs mainly differ from traditional IRAs in their tax treatment. With a Roth IRA, taxes are paid up front on contributions and conversions, and withdrawals generally are tax-free in retirement. With traditional IRAs, contributions may be tax-deductible, and withdrawals are taxed.

Roth IRA Investors Consistently Contribute and Rarely Withdraw

The report found that contribution activity is much more important to Roth IRA investors, with 71% of new Roth IRAs opened only with contributions. In recent years, nearly $20 billion of contributions has flowed into Roth IRAs each year.

“In any given year, Roth IRA investors are more likely to make contributions than traditional IRA investors,” states the ICI report. “In tax year 2012, about three in 10 Roth IRA investors (aged 18 or older) made contributions, compared with fewer than one in 10 traditional IRA investors (aged 25 to 69).”

Traditional IRAs are largely created through rollovers, as the ICI report found nearly nine in 10 new traditional IRAs in 2012 were opened only with rollovers. In contrast, about one in 10 Roth IRAs were created through rollovers in recent years. Not only are Roth IRA investors making contributions, but they are doing so at the legal limit and consistently year to year. According to the report, more than four in 10 investors who contributed did so at the legal limit, and more than two-thirds of investors who contributed at the limit in tax year 2011 did so again in tax year 2012.

Withdrawals from Roth IRAs are much lower than from traditional IRAs, mostly because traditional IRA investors 70½ or older must take required minimum distributions, while a Roth IRA has no RMDs during the account holder’s lifetime unless it’s inherited.

“In 2012, only 4% of Roth IRA investors aged 25 or older made withdrawals, compared with 22% of traditional IRA investors,” the ICI report said. “Early withdrawal penalties can apply to both Roth and traditional IRA investors aged 59½ or younger, and withdrawal activity is lower among investors younger than 60 compared with investors aged 60 or older.”

Roth IRA Investors Are to Apples as Traditional IRA Investors Are to Oranges

The ICI report found that Roth IRA assets are allocated more to equity holdings than are traditional IRA assets.

“Some of this higher average concentration in equity holdings reflects the younger average age of Roth IRA investors compared with traditional IRA investors and the tendency of younger investors to hold higher concentrations in equity holdings,” ICI stated in its report. “However, it also is the case that Roth IRA investors within any given age group tend to have higher concentrations in equity holdings.”

Based on year-end 2012 data, the report found  62% of Roth IRA assets were invested in equities and equity funds (mutual funds, ETFs, and closed-end funds), compared with 49% of traditional IRA assets

In correlation, the data also showed Roth IRAs had less allocated to bonds and bond funds, 10% versus the 20% traditional IRAs had allocated to bonds and bond funds. Roth IRAs had 9% allocated to money market funds, lower than the 13% allocated by traditional IRAs.

“Some of the differences in allocation reflect the different age distributions,” ICI stated in its report. “Another force at play is the impact of default rollover asset allocation to money market funds and deposits in traditional IRAs.”

The ICI report also found a considerable age gap between Roth IRA and traditional IRA investors, similar findings as were previously reported on by ThinkAdvisor. Roth IRA investors tend to be younger than traditional IRA investors, with 31% of Roth IRA investors under 40 and 14% of traditional IRA investors under 40. Meanwhile, 24% of Roth IRA investors were 60 or older, compared with 38% of traditional IRA investors.


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