National policies that have created or enhanced tax-advantaged savings accounts have proven integral to helping Americans prepare for retirement and other long-term savings goals. Because many Americans use mutual funds in tax-advantaged accounts to reach these long-term goals, ICI examines funds' role in the retirement and education savings markets, and the investors who use IRAs, 401(k) and 529 plans, and other long-term savings vehicles.

The U.S. Retirement Market

U.S. retirement assets topped $16 trillion in 2006, up 12 percent from 2005 and 40 percent from 2000 (Figure 7.1). The $16.4 trillion in retirement market assets is held in a variety of tax-advantaged plan types. The largest components are Individual Retirement Accounts (IRAs) and employer-sponsored defined contribution plans, holding $4.2 trillion and $4.1 trillion, respectively, at year-end 2006.

Other employer-sponsored pensions include private defined benefit pension funds (with $2.3 trillion in assets), state and local government employee retirement plans (with $3.0 trillion in assets), and federal government defined benefit plans and the federal employees' Thrift Savings Plan (with $1.1 trillion in assets). In addition, there were $1.6 trillion in annuity reserves at year-end 2006.

Figure 7.1

U.S. Retirement Assets Top $16 Trillion

(trillions of dollars, year-end, selected years)

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1Other plans include: all fixed and variable annuity reserves at life insurance companies less annuities held by IRAs, 403(b) plans, 457 plans, and private pension funds; federal, state, and local pension plans. Federal pension plans include U.S. Treasury security holdings of the civil service retirement and disability fund, the military retirement fund, the judicial retirement funds, the Railroad Retirement Board, and the foreign service retirement and disability fund. These plans also include securities held in the National Railroad Retirement Investment Trust and Federal Employees Retirement System (FERS) Thrift Savings Plan (TSP).
2Defined contribution plans include private employer-sponsored defined contribution plans (including 401(k) plans), 403(b) plans, and 457 plan assets.
Note: Components may not add to the total because of rounding.
Sources: Investment Company Institute, Federal Reserve Board, National Association of Government Defined Contribution Administrators, American Council of Life Insurers, and Internal Revenue Service Statistics of Income Division

Individual Retirement Accounts

At year-end 2006, IRA assets totaled $4.2 trillion, up 17 percent from year-end 2005 (Figure 7.2). Mutual fund assets held in IRAs were $2.0 trillion at year-end 2006, an increase of $305 billion, or 18 percent, from 2005. Assets managed by mutual funds are the largest component of IRA assets, followed by securities held directly through brokerage accounts ($1.6 trillion at year-end 2006). The mutual fund industry's share of the IRA market has increased from 22 percent in 1990 to 47 percent at year-end 2006.

Since 1990, assets in IRAs have grown primarily due to the investment performance of the securities held in IRA portfolios and rollovers into IRAs from employer-sponsored retirement plans. Various laws enacted since 1996 introduced new types of IRAs. Furthermore, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), enacted in 2001, increased the amount investors—especially those age 50 or older—can contribute to IRAs. The Pension Protection Act (PPA), enacted in 2006, made these EGTRRA enhancements permanent. ICI household survey data and Internal Revenue Service Statistics of Income Division tabulations of IRA contributions indicate households responded to these increased opportunities to save.

Figure 7.2

IRA Assets

(billions of dollars, 1990–2006)

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1Data are preliminary.
2Bank and thrift deposits include Keogh deposits.
3Life insurance company IRA assets are annuities held by IRAs, excluding variable annuity mutual fund IRA assets, which are included in mutual funds.
4Category excludes mutual fund assets held through brokerage accounts, which are included in mutual funds.
eData are estimated.
Note: Components may not add to the total because of rounding.
Sources: Investment Company Institute, Federal Reserve Board, American Council of Life Insurers, and Internal Revenue Service Statistics of Income Division

IRA Investors: Traditional, Roth, and Employer-Sponsored IRAs

Judging by the incidence of IRA ownership in U.S. households, IRAs are an important component in America's retirement savings strategy. Created in 1974 under the Employee Retirement Income Security Act (ERISA), IRAs were designed with two goals. First, they provide individuals not covered by workplace retirement plans with an opportunity to save for retirement on their own. They also allow workers changing jobs a means to preserve the tax benefits and growth opportunities that employer-sponsored retirement plans provide.

Nearly four out of 10 U.S. households, or 42.2 million, owned IRAs as of mid-2006 (Figure 7.3). An ICI survey finds that these IRA households generally are headed by middle-aged individuals with moderate household incomes. IRA owners are more likely to hold mutual funds, especially long-term mutual funds, in their IRA portfolios than any other type of investment.

Figure 7.3

Millions of Households Own IRAs

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Note: Multiple responses are included.
Sources: Investment Company Institute and U.S. Bureau of the Census

As of mid-2006, approximately 34.8 million U.S. households owned "traditional" IRAs—defined as those IRAs first allowed under ERISA—while about 14.4 million U.S. households owned Roth IRAs, first made available in 1998 under the Taxpayer Relief Act of 1997. An estimated 7.9 million U.S. households owned employer-sponsored IRAs (SIMPLE IRAs, SEP IRAs, or SAR-SEP IRAs).

Traditional IRAs. Households owning traditional IRAs held a median of $30,000 in these accounts in 2005, and had median household income of $62,500. Forty-three percent of these households had traditional IRAs that included assets "rolled over" from employer-sponsored retirement plans. Traditional IRA households with rollovers typically had two accounts; traditional IRA households without rollovers typically had one account. Twenty-six percent of traditional IRA households also owned Roth IRAs and 14 percent also owned employer-sponsored IRAs. Individuals heading households with traditional IRAs had a median age of 54 years, and 66 percent were employed.

Roth IRAs. The majority of households with Roth IRAs owned one Roth IRA account with a median balance of $10,000 in 2005, and these households had median income of $75,000. About 40 percent of Roth IRA households opened a Roth IRA as their first IRA. Sixty-one percent of households with Roth IRAs also owned traditional IRAs, and 16 percent also owned employer-sponsored IRAs. Individuals heading households with Roth IRAs had a median age of 45 years, and 86 percent were employed.

Employer-Sponsored IRAs. Households with employer-sponsored IRAs had a median of $25,000 in employer-sponsored IRAs and a total of $62,400 invested in all types of IRAs in 2005. Individuals heading households with employer-sponsored IRAs had a median age of 48 years and median household income of $78,400. Sixty percent of these households also owned traditional IRAs and 30 percent also owned Roth IRAs. Nearly two-fifths of individuals heading households with employer-sponsored IRAs were self-employed.

More than two-thirds of all households owning IRAs have IRA assets invested in mutual funds, usually stock mutual funds (Figure 7.4). Far fewer households own other types of investments in their IRAs: about two-fifths hold individual stocks, less than one-third hold annuities, and more than one-quarter hold
bank deposits.

Figure 7.4

Households Invest Their IRAs in Many Types of Assets

(percent of U.S. households owning any type of IRA, 2005)*

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*Multiple responses are included.
Source: Fundamentals, "Appendix: Additional Data on IRA Ownership in 2005"

Defined Contribution Plans

At the end of 2006, employer-sponsored defined contribution plans, which include 401(k) plans, 403(b) plans, 457 plans, Keoghs, and other defined contribution plans, held an estimated $4.1 trillion in assets (Figure 7.5). With $2.7 trillion in assets at year-end 2006, 401(k) plans held the largest share of employer-sponsored defined contribution plan assets. Two types of plans similar to 401(k) plans—403(b) plans, which allow employees of educational institutions and certain nonprofit organizations to receive deferred compensation, and 457 plans, which allow employees of state and local governments and certain tax-exempt organizations to receive deferred compensation—held another $834 billion in assets. The remaining $529 billion in defined contribution plan assets were held by other defined contribution plans without 401(k) features.

At the end of 2006, $1.5 trillion of 401(k) plan assets were invested in mutual funds (Figure 7.6). Mutual funds' share of the 401(k) market increased from 9 percent in 1990 to an estimated 55 percent at
year-end 2006.

Figure 7.5

Defined Contribution Plan Assets by Type of Plan

(billions of dollars, year-end, 1997–2006)

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eData are estimated.
*Other defined contribution plans include Keoghs and other defined contribution plans (profit sharing, thrift-savings, stock bonus, and money purchase) without 401(k) features.
Note: Components may not add to the total because of rounding.
Sources: Investment Company Institute, Federal Reserve Board, National Association of Government Defined Contribution Administrators, and American Council of Life Insurers

Figure 7.6

401(k) Plan Assets Reach $2.7 Trillion

(billions of dollars, year-end, 1990–2006)*

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*Data are preliminary.
eData are estimated.
Note: Components may not add to the total because of rounding.
Sources: Investment Company Institute, Federal Reserve Board, and Department of Labor

401(k) Participants: Asset Allocations, Account Balances, and Loans

For many American workers, 401(k) plan accounts have become an important part of retirement planning. The income these accounts provide in retirement depends, in part, on the asset allocation decisions of plan participants.

According to research conducted by ICI and the Employee Benefit Research Institute (EBRI), the asset allocations of 401(k) plan participants vary widely, depending on a variety of demographic and other factors. For example, younger participants tend to allocate a larger portion of their account balances to equity securities (which include equity mutual funds and other pooled equity investments and the company stock of the employer), while older participants are more likely to invest in fixed-income securities such as money funds, bond funds, and guaranteed investment contracts (GICs) and other stable value funds. On average, at year-end 2005, individuals in their twenties invested 62 percent of their assets in equity securities, 20 percent in fixed-income securities, and 16 percent in balanced funds (Figure 7.7). By comparison, individuals in their sixties invested 49 percent of their assets in equity securities, 39 percent in fixed-income securities, and 10 percent in balanced funds.

Figure 7.7

401(k) Asset Allocation Varies With Participant Age

(average asset allocation of 401(k) account balances, percent, 2005)

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*Funds include mutual funds and other pooled investments.
Note: Components do not add to 100 percent because of rounding.
Source: Tabulations from EBRI/ICI Participant-Directed Retirement Plan Data Collection Project (Perspective, "Appendix: Additional Figures for the EBRI/ICI Participant-Directed Retirement Plan Data Collection Project for Year-End 2005,")

The median age of 401(k) plan participants was 44 years old at year-end 2005, and the average account balance, excluding plan loans, was $58,328. Account balances tend to be higher the longer 401(k) plan participants have been working for their current employers and the older the participant. Workers in their sixties with at least 30 years of tenure at their current employers had an average 401(k) account balance of $180,988 (Figure 7.8).

Most 401(k) participants do not borrow from their plans. At year-end 2005, only 19 percent of those eligible for loans had loans outstanding. The average unpaid loan balance for these participants represented about 13 percent of their remaining account balances (net of the unpaid loan balances).

Figure 7.8

401(k) Balances Tend to Increase With Age and Job Tenure

(average 401(k) account balance, 2005)

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Source: Tabulations from EBRI/ICI Participant-Directed Retirement Plan Data Collection Project (Perspective, "Appendix: Additional Figures for the EBRI/ICI Participant-Directed Retirement Plan Data Collection Project for Year-End 2005")

Services and Expenses in 401(k) Plans

In deciding whether or not to offer 401(k) plans to their workers, employers must decide if the benefits of offering a plan (in attracting and retaining quality workers) outweigh the costs of providing the plan and plan services (both the compensation paid to the worker and any other costs associated with maintaining the plan and each individual plan participant account).

401(k) plans are complex to maintain and administer, and are subject to an array of rules and regulations that govern their operation. Employers offering 401(k) plans typically hire service providers to operate these plans, and these providers charge fees for their services.

As with any employee benefit, the employer generally determines how the costs will be shared between the employer and employee. Fees can be paid directly by the plan sponsor (i.e., the employer), paid directly by the plan participant (i.e., the employee), paid indirectly by the participant through fees or other reductions in returns paid to the investment provider, or by some combination of these methods (Figure 7.9).

Figure 7.9

A Variety of Arrangements May Be Used to Compensate 401(k) Service Providers

Note: In selecting the service provider(s) and deciding the cost-sharing for the 401(k) plan, the employer/plan sponsor will determine which combinations of these fee arrangements will be used in the plan.
Source: Fundamentals, "The Economics of Providing 401(k) Plans: Services, Fees, and Expenses"

As noted, about half of 401(k) assets at year-end 2006 were invested in mutual funds. 401(k) plan participants in mutual funds tend to invest in low-cost funds with below-average portfolio turnover. Both characteristics help to keep down the costs of investing in mutual funds through 401(k) plans. For example, at year-end 2005, 22 percent of 401(k) stock mutual fund assets were in funds that had total annual expense ratios below 0.50 percent of fund assets, and another 55 percent had expense ratios between 0.50 and 1.00 percent (Figure 7.10). On an asset-weighted basis, the average total expense ratio incurred on 401(k) participants' holdings of stock mutual funds was 0.76 percent, compared with an average total expense ratio of 0.90 percent for stock mutual funds industrywide.

Figure 7.10

401(k) Stock Mutual Fund Assets Are Concentrated in Low-Cost Funds

(percent of 401(k) stock mutual fund assets, 2005)

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*The total expense ratio, which is reported as a percentage of fund assets, includes fund operating expenses and 12b-1 fees.
Note: Figures exclude mutual funds available as investment choices in variable annuities.
Sources: Investment Company Institute and Lipper (Fundamentals, "The Economics of Providing 401(k) Plans: Services, Fees, and Expenses")

Mutual Funds' Role in Households' Retirement Savings

At year-end 2006, mutual funds accounted for $4.1 trillion, or 25 percent, of the $16.4 trillion U.S. retirement market (Figure 7.11). The remaining $12.3 trillion of year-end 2006 retirement market assets were managed by pension funds, insurance companies, banks, and brokerage firms.

Figure 7.11

Mutual Funds Account For 25 Percent of Retirement Market Assets in 2006

(trillions of dollars, year-end, 2000–2006)

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*Data are preliminary.
Note: Components may not add to the total because of rounding.
Sources: Investment Company Institute, Federal Reserve Board, National Association of Government Defined Contribution Administrators, American Council of Life Insurers, and Internal Revenue Service Statistics of Income Division

The $4.1 trillion in mutual fund retirement assets represented 39 percent of all mutual fund assets at year-end 2006. Retirement savings accounts are a significant portion of long-term mutual fund assets (47 percent), but are a relatively minor share of money market mutual fund assets (13 percent).

Mutual fund retirement assets primarily come from two sources: IRAs and employer-sponsored defined contribution plans, such as 401(k) plans. Investors hold roughly the same amount of mutual fund assets in IRAs as they do in employer-sponsored defined contribution plans. At year-end 2006, IRAs held $2.0 trillion in mutual fund assets and employer-sponsored defined contribution plans had $2.1 trillion (Figure 7.12). Among defined contribution plans, 401(k) plans are the largest holder of mutual funds, with $1.5 trillion in assets (Figure 7.13). At year-end 2006, 403(b) plans held $363 billion in mutual fund assets, 457 plans held $69 billion, and other defined contribution plans held $195 billion.

Figure 7.12

Mutual Fund Retirement Assets1

(billions of dollars, year-end, 1991–2006)

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1Data are preliminary.
2Defined contribution plans include 401(k) plans, 403(b) plans, 457 plans, Keoghs, and other defined contribution plans without 401(k) features.
Note: Components may not add to the total because of rounding.
Sources: Investment Company Institute, Federal Reserve Board, and Department of Labor

Types of Mutual Funds Used by Retirement Plan Investors

Of the $4.1 trillion in mutual fund retirement assets held in IRAs, 401(k) plans, and other retirement accounts at year-end 2006, $2.8 trillion, or 70 percent, were invested in domestic or foreign equity funds (Figure 7.13). Domestic equity funds alone constituted about $2.3 trillion, or 56 percent, of mutual fund retirement assets. By comparison, about 57 percent of overall fund industry assets—including retirement and nonretirement accounts—were invested in domestic and foreign equity funds at year-end 2006.

Figure 7.13

Bulk of Mutual Fund Retirement Assets Invested in Equities1

(billions of dollars, 2006)

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1Data are preliminary.
2Other defined contribution plans include 457 plans, Keoghs, and other defined contribution plans without 401(k) features.
Note: Components may not add to the total because of rounding.

At year-end 2006, approximately $664 billion, or 16 percent, of mutual fund retirement assets were invested in fixed-income funds (bond or money market funds). Bond funds held $356 billion, or 9 percent, of mutual fund retirement assets, and money market funds accounted for $308 billion, or 8 percent. The remaining $572 billion, or approximately 14 percent, of mutual fund retirement assets were held in hybrid funds, which invest in a mix of equity and fixed-income securities.

Lifestyle and Lifecycle Funds. Lifestyle and lifecycle funds, generally included in the hybrid fund category, have grown in popularity among investors and retirement plan sponsors in recent years. Lifestyle funds maintain a predetermined risk level and generally use words such as "conservative," "moderate," or "aggressive" in their names to indicate the fund's risk level. Lifecycle funds follow a predetermined reallocation of risk over time to a specified target date, and typically rebalance their portfolios to become more conservative and income-producing by the target date, which is usually indicated in the fund's name. About $303 billion was invested in lifestyle and lifecycle funds at the end of 2006, with lifestyle funds holding $189 billion of assets and lifecycle funds holding $114 billion (Figure 7.14). The bulk (90 percent) of lifecycle fund assets was held in retirement accounts, compared with about 47 percent of lifestyle fund assets.

Figure 7.14

Lifecycle and Lifestyle Fund Assets by Account Type1

(billions of dollars, year-end, 1996 –2006)

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1Data are preliminary.
2A lifecycle mutual fund is a hybrid fund that typically rebalances to an increasingly conservative portfolio as the target date of the fund,
which is usually included in the fund's name, approaches.
3A lifestyle mutual fund maintains a predetermined risk level and generally uses words such as "conservative," "aggressive," or "moderate" in the fund's name.
*Components not labeled are less than $1 billion.
Note: Components may not add to the total because of rounding.

Mutual Funds' Role in Households' Education Savings

According to the Federal Reserve Board's 2004 Survey of Consumer Finances, about 12 percent of all U.S. households consider future education expenses their most important motivation for saving, compared with 11 percent of households in 2001.

In addition, ICI research finds that 30 percent of households owning mutual funds in 2004 cite education as a financial goal for their fund investments. Nevertheless, the demand for education savings vehicles has been historically modest since their introduction in the 1990s, partly because of their limited availability and investors' lack of familiarity with them. The enactment of EGTRRA in 2001 enhanced the attractiveness of both Section 529 plans and Coverdell Education Savings Accounts (ESAs)—two education savings vehicles—by allowing greater contributions and flexibility in the plans. The enactment of the PPA in 2006 made permanent the EGTRRA enhancements to Section 529 plans.

Assets in Section 529 savings plans grew 31 percent in 2006, increasing from $68.7 billion at year-end 2005 to $90.1 billion by year-end 2006 (Figure 7.15). The number of accounts rose to 7.2 million, and the average account size was approximately $12,500 at year-end 2006.

Figure 7.15

Section 529 Savings Plan Assets Continue to Grow

(billions of dollars, year-end, 1998–2006)

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Note: Data were estimated for a few individual state observations in order to construct a continuous time series.
Sources: Investment Company Institute and College Savings Plans Network

Mutual funds accounted for an estimated 96 percent of the $90.1 billion Section 529 savings plan market at year-end 2006. Funds also managed $5 billion in Coverdell ESA—formerly Education IRA—assets at year-end 2006.

A 2003 ICI survey of households with children age 18 or younger found that households use a variety of investments to save for college. Indeed, 93 percent of households saving for college used taxable investments to achieve this financial goal (Figure 7.16). Forty-two percent of parents saving for college used U.S. Savings Bonds. Twenty percent of parents saving for college used education-targeted savings programs, such as state-sponsored 529 prepaid tuition plans, state-sponsored 529 college savings plans, and Coverdell ESAs. Most of the parents using education-targeted savings programs were also saving for college with taxable investments.

Figure 7.16

Households Use Multiple Investments to Save for College

(percent of respondents saving for college, 2003)1

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¹Multiple responses are included.
²Education-targeted savings programs include state-sponsored 529 prepaid tuition plans, state-sponsored 529 college savings plans, and Coverdell ESAs.
Source: Profile of Households Saving for College