Roth IRAs Most Often Created by Contributions

Unlike traditional individual retirement accounts (IRAs), contributions are the predominant way investors open Roth IRAs, according to a new Investment Company Institute (ICI) analysis.

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. In fact, about nine in 10 traditional IRAs that opened in 2012 were created using rollovers from other retirement accounts (see “For IRAs, It’s All About the Rollover”).

The ICI’s new report, “The IRA Investor Profile: Roth IRA Investors’ Activity, 2007 to 2012,” analyzes the contributions, conversions, rollovers, withdrawals, asset allocations and account balances of two populations of Roth IRA investors. These populations include 2.5 million “consistent” Roth IRA investors (those with accounts in every year between 2007 and 2012), as well as a broader snapshot of 5.1 million Roth IRA investors at year-end 2012. The report results are based on The IRA Investor Database, a joint project by the ICI and the Securities Industry and Financial Markets Association (SIFMA).

The database has information on 15.5 million IRA investors at year-end 2012, of which 68% hold traditional IRAs, 33% hold Roth IRAs, and 14% hold employer-sponsored IRAs—with some holding more than one type of IRA. Roth IRAs mainly differ from traditional IRAs in their tax treatment, ICI researchers explain. With a Roth IRA, taxes are paid up front on contributions and conversions, and withdrawals are generally tax-free in retirement. With traditional IRAs, contributions may be tax-deductible, and withdrawals are taxed.

“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,” explains Sarah Holden, ICI senior director of retirement and investor research. “The availability of both traditional and Roth IRAs provides flexibility for households to manage the timing of taxation of their retirement accumulations.”

The analysis shows nearly $20 billion in contributions flowed into Roth IRAs each year during the sample period. In any given year, more than three in 10 Roth IRA investors made contributions to their accounts. In 2012, 30.3% of Roth IRA investors ages 18 and older contributed at least some funds, and more than four in 10 investors who contributed did so at the legal limit. Roth IRA investors also persisted in their contribution activity year to year. For example, more than two-thirds of investors who contributed at the limit in tax year 2011 did so again in tax year 2012.

While few Roth IRAs in a typical year are created through conversions from other qualified retirement assets, Roth IRA conversion activity tended to shift in direct response to tax rule changes, ICI researchers explain. For example, in 2010, when income limits on conversions were lifted and taxpayers could choose to spread out taxes on conversions made in 2010 over the next two years, one-third of new Roth IRAs were opened only with conversions. 

In 2010, more than 5% of Roth IRA investors made conversions into their Roth IRAs, compared with less than 2% in 2008 and 2009. Conversion activity shrank when the special tax payment option expired, but is still higher than before 2010. In 2012, for example, 2.6 % of Roth IRA investors made conversions into their Roth IRAs.

The ICI says fewer than one in 25 Roth IRA investors took withdrawals in 2012. In contrast to traditional IRAs, which require investors aged 70½ or older to take required minimum distributions (RMDs), Roth IRAs do not require RMDs during the account holder’s lifetime. As a result, withdrawal activity is much lower among Roth IRA investors and varies much less by age, compared with traditional IRA investors.

The full report can be downloaded here.