Too many investors view IRAs simply as parking accounts for their rollover 401(k) money.
Millions of American have IRAs. Some people, like me, have multiple IRAs, but hardly anyone makes regular contributions to these accounts. According to a recent study by the Investment Company Institute (ICI), only 8.7% of investors with a traditional (non-Roth) IRA contributed to them in tax year 2013.
The Employee Benefit Research Institute’s IRA database, which tracks 25 million IRA accounts, estimates an even smaller percentage of investors contributed to their traditional IRA accounts—just 7%.
The problem, it seems, is that many people have come to see IRAs as a place to park money rather than as a savings vehicle that needs regular, new contributions. Most IRAs are initially established with money that is rolled over from an employer-sponsored 401(k) when a worker changes jobs or retires.
As savings options, IRAs are inferior to 401(k)s, which typically offer employer matches and a tax deduction for your contribution. With IRAs, the deduction for contributions is more limited. If you are already covered by a plan at work, you qualify for a tax deduction to a traditional IRA only if your income is $61,000 or less. Moreover, the contribution limit for IRAs is low—$5,500 a year, or $6,500 if you’re 50 and older. By contrast, the contribution limit for a 401(k) is $18,000 this year ($24,000 for those 50 and older).
Still, traditional IRA accounts will let your money grow tax-deferred; with Roth IRAs, you contribute after-tax money, which will grow tax-free. Adding an extra $5,500 a year to your savings today can make a sizable difference to your retirement security. Even if you don’t qualify for a deduction, you can make a nondeductible contribution to an IRA. (Be sure to file the required IRS form, 8606, when you make nondeductible contributions to avoid tax headaches.) Still, as these new findings show, most people don’t contribute new money to any IRA.
I get it. I have two traditional IRAs from rollovers and have been making the mistake of not contributing more to them for years. Since my traditional IRAs were started with a lump sum, I mistakenly viewed them as static (though still invested) nest eggs. If I had thought of them as active vehicles to which I should contribute annually, I would be on much firmer footing in terms of my “retirement readiness.” (I also have a SEP-IRA that I can only contribute to from freelance income, and a Roth IRA which I converted from a third rollover IRA one year when it made sense tax-wise to do so, but also now can’t contribute to. No wonder I find IRAs confusing.)
The ICI’s report suggests that very low contribution rates for IRAs “are attributable to a number of factors, including that many retirement savers are meeting their savings needs through employer-sponsored accounts.” But that explanation is misleading. Even those lucky enough to have access to 401(k)s need to have been making the absolute maximum contributions every year since they were 23 years old to feel confident they’re saving enough.
IRAs are a valuable and often overlooked part of the whole plan—and for many without 401(k)s, they are THE whole plan. There has been a lot of attention on improving 401(k) plan participation rates by automatically enrolling employees. But only recently has there been more focus by policymakers on getting people to contribute to their IRAs on a regular basis, including innovations like President Obama’s MyRA savings accounts and efforts by Illinois and other states to create state savings plans for workers who lack 401(k)s. These are worthy projects that need an even bigger push.
Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.