Since 1998, eligible working Americans have been able to contribute post-tax wages to a Roth IRA, an individual retirement account (IRA) created by the Taxpayer Relief Act of 1997. The investment earnings in the account are tax free, as are any subsequent distributions.
The idea, according to Senate testimony from Vaughn Hobson, an office manager in Raleigh, N.C., was to help “hard-working, middle-class” Americans in saving for retirement by “putting money aside to supplement [a] single pension.”
However, a group of wealthy Americans have amassed much larger returns in these accounts than would be possible simply by contributing the maximum amount each year and investing in a fund that tracks the S&P 500’s performance, according to a 2021 report by the nonprofit newsroom ProPublica.
Here is some of what we know about the “Roth IRA wealth gap,” an unofficial term we’re using to describe disparities in the values of Americans’ Roth IRAs. We’ll also discuss apparent differences in the performance of high-income Americans’ Roth and traditional IRAs, as well as other IRA disparities that you should know about as they relate to race and ethnicity.
- Federal law created Roth individual retirement accounts (Roth IRAs) with the stated purpose of helping hardworking, middle-class Americans through tax-free growth and distributions for their retirement savings.
- Roth IRAs appear to have performed disproportionately better for high-income individuals than for low-income individuals, even after adjusting for risk, according to the first draft of an academic study released in December 2021.
- The types of assets that wealthy people hold in their portfolios—not just higher incomes and savings rates—may be an important contributor to wealth inequality.
First Draft of New Study Shows Roth IRA Wealth Gap
“The Unintended Consequences of Roth IRAs” by Lorenzo Bretscher, Riccardo Sabbatucci, and Andrea Tamoni finds that, even after adjusting for risk, high-income individuals earning more than $200,000 annually outperform low-income individuals earning $200,000 or less annually by a factor of three to one in their Roth IRA portfolios under the most conservative assumptions.
The study has not yet been peer reviewed or accepted for publication in a journal, and, as of March 17, 2022, the authors are collecting comments and feedback on their first draft, available on the open-access research platform SSRN. This process is typical for academic studies and is a normal step toward possible journal acceptance and publication.
Each of the three authors is affiliated with a highly regarded academic institution: the London Business School, the Stockholm School of Economics, and Rutgers Business School. Still, it is possible that the authors could revise their findings based on the feedback that they receive, so keep that in mind as you read this article.
How Big Is the Roth IRA Wealth Gap?
The Internal Revenue Service (IRS) does not publish sufficiently detailed data to answer this question with complete accuracy. Instead, we must rely on expert researchers to analyze the data that the IRS does provide and arrive at a plausible approximation.
The study’s authors analyzed data that the IRS collected from IRA tax filings for the years 2004 through 2018. Data before 2004 was unavailable or reported differently. The latest year of data available is 2019.
The authors placed all taxpayers with IRA tax filings for these tax years into one of two groups: those with an adjusted gross income (AGI) of less than $200,000, which the authors call “low income,” and taxpayers with an AGI of $200,000 or more, which the authors call “high income.” They found that the low-income group earned average annual returns of 3.6% in their Roth IRAs over the study period, while the high-income group earned 8.5%. Cumulatively, high-income individuals earned 171% more than low-income individuals from 2004 through 2018 under the authors’ most conservative assumptions.
Wealthy Investors Appear to Earn Higher Returns in Roth IRAs Than Traditional IRAs
Another way to define “Roth IRA wealth gap” is to consider the difference in returns that wealthy Americans appear to earn in Roth vs. traditional IRAs. “The performance of high-income individuals is much more impressive in ‘tax-free’ Roth IRA than in traditional IRA plans,” Bretscher, Sabbatucci, and Tamoni write.
Under the three different scenarios that the authors ran, high-income individuals earned absolute returns in their Roth IRA portfolios that were at least twice as large as the returns that high-income individuals earned in traditional IRAs. The authors say they “plan to investigate the sources of this differential performance...in future research.”
That said, according to the authors, higher-income people seem to intentionally put assets that are likely to earn higher returns into Roth IRAs rather than traditional IRAs. Peter Thiel seems to have done this with his early PayPal shares, as reported in June 2021 by ProPublica.
Of course, a low-cost asset held in a Roth IRA won’t necessarily become a top performer, but if it does, then the investor has more potential upside than if the same asset were held in a traditional IRA. Why? Because traditional IRAs require the account holder to pay taxes on qualified distributions and to take required minimum distributions (RMDs) starting at age 73 for people born between 1951 and 1959 and age 75 for those born in 1960 or later. By contrast, qualified distributions from Roth IRAs are not taxable (this is what the authors mean by “tax free”), and Roths don’t have RMDs in the account holder’s lifetime.
Other IRA Wealth Gaps
The amount of wealth that Americans held in IRAs (not Roth IRAs exclusively) in 2018 varied by race and Hispanic origin, according to U.S. Census Bureau data. This difference represents one part of the racial wealth gap.
|Value of Americans’ IRAs in 2018|
|Race and Hispanic Origin of Householder||Median Value||Average Value|
|White alone, not Hispanic||$60,000||$238,400|
|Hispanic origin (any race)||$21,000||$103,100|
|Not of Hispanic origin||$54,000||$224,900|
Most Americans did not even have IRAs in 2018, according to U.S. Census Bureau data, and the percentage of households that owned IRAs also varied by race and Hispanic origin.
|Percentage of Americans with IRAs in 2018|
|Race and Hispanic Origin of Householder||IRA or Keogh Accounts|
|White alone, not Hispanic||38.1%|
|Hispanic origin (any race)||13.9%|
|Not of Hispanic origin||33.3%|
What is the Roth individual retirement account (Roth IRA) wealth gap?
The Roth individual retirement account (Roth IRA) wealth gap refers to the disparity between how much lower-income households have accumulated through saving and investing in Roth IRAs compared with higher-income households. Another way to define “Roth IRA wealth gap” relates to the difference in returns that high-income Americans appear to earn in Roth vs. traditional IRAs by placing assets with higher growth potential in Roths.
What policies have legislators proposed or passed to limit wealth accumulation in Roth IRAs?
- Retirement Improvements and Savings Enhancements (RISE) Act—This 2016 proposal sought to eliminate the backdoor Roth IRA and limit further contributions to Roth IRAs valued at more than $5 million.
- Tax Cuts and Jobs Act (TCJA)—This 2017 law eliminated the ability to recharacterize (undo) traditional IRA-to-Roth IRA conversions, along with making many other changes to Americans’ personal finances.
- Setting Every Community Up for Retirement Enhancement (SECURE) Act—This 2019 law eliminated the so-called “stretch IRA” that allowed IRA beneficiaries who aren’t spouses (for example, an adult child who inherited a parent’s IRA) to turn inherited IRA assets into generational wealth.
- Build Back Better Act—This 2021 proposal by House Democrats sought to require minimum distributions from IRAs with balances exceeding $10 million and eliminate backdoor Roth IRA contributions for taxpayers with income exceeding $450,000 for a joint return, $400,000 for singles, and $425,000 for heads of household starting in 2022.
Is a Roth IRA better than a traditional IRA?
No. Neither type of IRA is inherently better than the other. The optimal choice depends on many factors, including your earnings and state of residence in any given tax year and your expectations for future tax rates.
The Bottom Line
A study from December 2021, titled “The Unintended Consequences of Roth IRAs” and authored by Lorenzo Bretscher, Riccardo Sabbatucci, and Andrea Tamoni, offers additional insights into how Americans are accumulating wealth in their Roth and traditional IRAs. The research may prove to be an important contribution to our understanding of tax policy and wealth disparities.
U.S. Congress. “Public Law 105–34—Aug. 5, 1997: Taxpayer Relief Act of 1997: Sec. 302. Establishment of Nondeductible Tax-Free Individual Retirement Accounts.,” Pages 39–43.
U.S. Senate Committee on Finance. “Hearing on the Bentsen-Roth IRA, S. 612,” Page 11 (Page 15 of PDF).
ProPublica. “Lord of the Roths: How Tech Mogul Peter Thiel Turned a Retirement Account for the Middle Class Into a $5 Billion Tax-Free Piggy Bank.”
SSRN. “The Unintended Consequences of Roth IRAs,” Pages 19 and 21.
SSRN. “SSRN Paper Submission Process,” Page 2.
SSRN. “What Is SSRN?”
London Business School. “Lorenzo Bretscher.”
Internal Revenue Service. “SOI Tax Stats — Accumulation and Distribution of Individual Retirement Arrangements (IRA).”
SSRN. “The Unintended Consequences of Roth IRAs,” Page 6, Footnote 6.
SSRN. “The Unintended Consequences of Roth IRAs,” Page 6, Footnote 7.
SSRN. “The Unintended Consequences of Roth IRAs,” Page 15, Tables B and C.
SSRN. “The Unintended Consequences of Roth IRAs,” Page 13 and Page 15, Table C.
SSRN. “The Unintended Consequences of Roth IRAs,” Page 19.
SSRN. “The Unintended Consequences of Roth IRAs,” Page 25.
SSRN. “The Unintended Consequences of Roth IRAs,” Page 4.
Internal Revenue Service. “Retirement Topics — Required Minimum Distributions (RMDs).”
Internal Revenue Service. “Roth IRAs.”
U.S. Census Bureau. “Wealth, Asset Ownership, & Debt of Households Detailed Tables: 2018,” Wealth Tables, Tables 1 and 5. Download required.
U.S. Census Bureau. “Wealth, Asset Ownership, & Debt of Households Detailed Tables: 2018,” Wealth and Asset Ownership Tables, Tables 1 and 5. Download required.
U.S. Senate Committee on Finance. “Wyden Proposal Would Crack Down on Tax Avoidance in Retirement Plans, Create New Opportunities for Working Americans to Save.”
Internal Revenue Service. “IRA FAQs: Recharacterization of IRA Contributions.”
U.S. Congress. “H. R. 1994, Title IV, Sec. 401.”
Congressional Research Service. “Tax Provisions in the ‘Build Back Better Act:’ The House Ways and Means Committee’s Legislative Recommendations,” Pages 53–54 (Pages 55–56 of PDF).