Investors Still Misunderstand Roth IRAs

New research shows that most investors ages 21 to 50 are generally familiar with the tax advantages of IRAs and have used them to save for retirement.

However, some appear to confuse the specific benefits of traditional individual retirement accounts (IRA) and Roth IRAs, the two most commonly used IRAs, according to a T. Rowe Price survey.  

When asked how familiar they are with IRAs, 70% of respondents described themselves as “familiar” or “very familiar.” In addition, 79% said they have personally contributed to an IRA.Generally, investors seem to understand that IRAs may bring tax advantages such as tax-deferred earnings, tax deductibility or tax-free withdrawals, but some investors do not appear to fully understand which benefits are associated with traditional IRAs and which are associated with Roth IRAs.  

For example, nearly half (48%) of investors in the study correctly cited tax-deferred growth potential and the ability to reduce taxable income with tax-deductible contributions as features of Traditional IRAs. However, one-fifth (21%) incorrectly cited the ability to withdraw savings without paying taxes after age 59.5 if the account has been open for at least five years as a benefit of Traditional IRAs, which instead is a benefit of Roth IRAs.  

Similarly, about half (51%) of respondents correctly cited tax-free growth potential as a benefit of Roth IRAs and almost one-third (31%) knew that Roth IRAs provide for tax-free withdrawals after age 59.5 if an account has been open for at least five years. But, about one-fifth (21%) incorrectly believed that Roth IRAs allowed for tax-deductible contributions.  

“It’s encouraging that a majority of younger investors are familiar with IRAs, generally understand that the accounts offer tax advantages, and have used IRAs to save for retirement,” said Christine Fahlund, senior financial planner with T. Rowe Price. “But it appears that there’s more that we can do to teach younger investors about the different types of IRAs so they can make more informed choices. For investors without access to a workplace retirement plan, IRAs are the only accounts available to save specifically for retirement. The challenge and responsibility of educating each new generation of young investors while they still have decades to save must be paramount for parents, educators, employers and financial institutions.”