Ed Slott Analyzes EBRI Study: Roth IRAs Growing TWICE as Fast as Traditional IRAs

By The Slott Report Staff
Follow Me on Twitter: @theslottreport

In lieu of today’s Slott Report Mailbag, we wanted to share an important study from EBRI on IRAs and Roth IRAs. Ed Slott was contacted and extensively interviewed on the report’s findings. Below, we will break down the important numbers as well as Ed’s detailed analysis on what it all means in the retirement planning landscape.

First, here’s the link to the article: http://www.thinkadvisor.com/2014/05/21/roth-iras-growing-twice-as-fast-as-traditional-ira

Key Numbers:

• 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 
• Almost 2.4 million IRA 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 overall average IRA balance increased each year — from $95,431 in 2010 to $95,547 in 2011 and to $106,205 in 2012
• 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

Ed’s Analysis:

Beginning in 2010, the tax law repealed the income restrictions on Roth IRA conversions allowing everyone to convert their IRAs to Roth IRAs regardless of their income. This 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. 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.

Also adding to the surge of 2010 Roth conversions was a Roth conversion sweetener – the so called “2-year deal” where no Roth conversion income had to be reported in 2010 and you could spread that conversion income over 2 years (2011 and 2012). That 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.

Roth conversions continued in 2011 and 2012 and still today even without the 2-year deal, but the rush in 2010 was the big push and made people think more about paying tax now to build a tax-free retirement fund. The sweetener worked and created awareness of the Roth IRA benefits. It also filled the government coffers with much needed revenues so it was a win-win – a rarity for taxpayers and Uncle Sam.

Also, Roth IRAs have no required minimum distributions like IRAs do, and people like that too. 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 upfront was worth the benefits of not having to worry about future higher taxes. The Roth IRA removes the uncertainty of what future higher tax rates might do to retirement savings.

In addition to the favorable tax changes, the stock market rally took those newly converted Roth balances to all time highs, which continues still today, and all of those gains are tax free in the Roth IRA (once age 59 1/2 and the funds are held for 5 years). Those who converted to Roth IRAs in 2010 will have met the 5-year requirement on January 1, 2015.

Another obvious conclusion from the study was that rollover amounts exceeded contributions. 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, as opposed to Roth contributions, which are subject to the annual limits. Another reason rollovers increased is due to demographics – baby boomers leaving jobs, retiring and rolling their 401(k) balances to IRAs. These are generally large balances.

The finding that young people are taking advantage of Roth IRAs also makes sense and shows us that 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. In fact that is the core theme of my book “Fund Your Future, A Tax-Smart Savings Plan in Your 20s and 30s.”

Younger workers give up an upfront 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. I wish I had that option in my 20s! Roth IRAs are a no-brainer for younger workers and the new study confirms that – and it confirms that they are getting the message. That’s good news.