The Roth IRA Wealth Gap

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.

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The study has not yet been peer reviewed or accepted for publication in a journal, and, as of March 17, 2022, the authors are collecting comments and feedback on their first draft, available on the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.

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.

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.