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This chapter analyzes the U.S. retirement market; describes the investors who use IRAs, 401(k) plans, 529 plans, and other tax-advantaged savings vehicles; and explores the role of mutual funds in U.S. households’ efforts to save for retirement and education.

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 goals, ICI studies the U.S. retirement market; the investors who use IRAs, 401(k) plans, 529 plans, and other tax-advantaged savings vehicles; and the role of funds in the retirement and education savings markets.

The U.S. Retirement System

American households rely on a combination of resources in retirement and the role each type plays has changed over time and varies across households. The traditional analogy compares retirement resources to a three-legged stool. This analogy implies that everyone has resources divided equally among Social Security, employer-sponsored pension plans, and private savings. This is not an accurate picture of Americans’ retirement resources. A five-layer pyramid is a better representation of retirement resources.

The Retirement Resource Pyramid

The retirement resource pyramid has five basic components, which draw from government programs, deferral of compensation until retirement, and other savings. The five components of the retirement resource pyramid are (1) Social Security; (2) homeownership; (3) employer-sponsored retirement plans (private-sector and government employer plans, as well as both defined benefit (DB) and defined contribution (DC) plans); (4) individual retirement accounts (IRAs), including rollovers; and (5) other assets (Figure 7.1). The importance of these five components in providing retirement resources differs from household to household. In their entirety, these five components have allowed recent generations of retirees, on average, to maintain their standard of living in retirement.

Figure 7.1

Retirement Resource Pyramid

Figure 7.1

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Source: Investment Company Institute, The Success of the U.S. Retirement System

 

Social Security, which represents the base of the U.S. retirement resource pyramid, is the largest component of retiree income and the predominant income source for lower-income retirees. Social Security benefits are funded through a payroll tax equal to 12.4 percent of earnings of covered workers (6.2 percent paid by employees* and 6.2 percent paid by employers) up to a maximum taxable earnings amount ($110,100 in 2012). The Social Security benefit formula is highly progressive, with benefits representing a much higher percentage of earnings for workers with lower lifetime earnings. For individuals born in the 1940s, the Congressional Budget Office (CBO) projects that Social Security benefits will replace, on average, 70 percent of average lifetime earnings for the bottom 20 percent of retired workers ranked by household lifetime earnings (Figure 7.2). This replacement rate drops to 47 percent for the second quintile of retired workers, and then declines more slowly as lifetime earnings increase. For even the top 20 percent of earners, Social Security benefits are projected to replace a considerable fraction (29 percent) of earnings. Social Security has become a system designed to be the primary means of support for retirees with low lifetime earnings and a substantial source of income for all retired workers.

* For 2011 and 2012, this rate was temporarily changed to 4.2 percent.

For many near-retiree households, homeownership represents the second most important retirement resource after Social Security. Older households are more likely to own their homes; more likely to own their homes without mortgage debt; and, if they still have mortgages, are more likely to have small mortgages relative to the value of their homes. Retired households typically access this resource simply by living in their homes and not paying rent.

Figure 7.2

Social Security Benefit Formula Is Highly Progressive

CBO estimates of median first-year benefits relative to average indexed earnings by household lifetime earnings, 1940s birth cohort, percent

Figure 7.2

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Source: Congressional Budget Office (The 2012 Long-Term Projections for Social Security: Additional Information)

Employer-sponsored retirement plans and IRAs play a complementary role to Social Security benefits, increasing in importance for households for whom Social Security replaces a smaller share of earnings. Nevertheless, employer-sponsored plans and IRAs are an important resource for households regardless of income or wealth. In 2010, about 80 percent of near-retiree households had accrued benefits in employer-sponsored retirement plans—DB and DC, private-sector and government employer plans—or IRAs (Figure 7.3).

Although less important on average, retirees also rely on other assets in retirement. These assets can be financial assets—including bank deposits and stocks, bonds, and mutual funds owned outside of employer-sponsored retirement plans and IRAs; and nonfinancial assets—including business equity, investment real estate, second homes, vehicles, and consumer durables (long-lived goods such as household appliances and furniture). Higher-income households are more likely to have significant holdings of assets in this category.

Figure 7.3

Near-Retiree Households Across All Income Groups Have Retirement Assets, DB Plan Benefits, or Both

Percentage of near-retiree households1 by income group,2 2010

Figure 7.3

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1Near-retiree households are those with a working head of household aged 55 to 64, excluding the top and bottom 1 percent of the income distribution.
2Total is household income before taxes in 2009.
3Retirement assets include DC plan assets (401(k), 403(b), 457, thrift, and other DC plans) and IRAs (traditional, Roth, SEP, SAR-SEP, and SIMPLE), whether from private-sector or government employers.
4DB plan benefits include households currently receiving DB plan benefits and households with the promise of future DB plan benefits, whether from private-sector or government employers.
Note: Components may not add to the total because of rounding.
Source: Investment Company Institute tabulations of the Survey of Consumer Finances. See The Success of the U.S. Retirement System.

Snapshot of U.S. Retirement Market Assets

Employer-sponsored retirement plans (DB and DC; private-sector and government employers), IRAs (including rollovers), and annuities play an important role in the U.S. retirement system. Such retirement assets totaled $19.5 trillion at year-end 2012, up 8.6 percent from year-end 2011 (Figure 7.4). The largest components of retirement assets were IRAs and employer-sponsored DC plans, holding $5.4 trillion and $5.1 trillion, respectively, at year-end 2012. Other employer-sponsored pensions include private-sector DB pension funds ($2.6 trillion), state and local government employee retirement plans ($3.2 trillion), and federal government plans—which include both federal employees’ DB plans and the Thrift Savings Plan ($1.6 trillion). In addition, there were $1.7 trillion in annuity reserves outside of retirement plans at year-end 2012.

Figure 7.4

U.S. Retirement Assets Rose in 2012

Trillions of dollars, year-end, selected years

Figure 7.4

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1Other plans include private-sector DB plans; federal, state, and local pension plans; and 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 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).
2DC plans include 401(k) plans, 403(b) plans, 457 plans, Keoghs, and other DC plans without 401(k) features.
3IRAs include traditional IRAs, Roth IRAs, and employer-sponsored IRAs (SEP IRAs, SAR-SEP IRAs, and SIMPLE IRAs).
eData are estimated.
Note: Components may not add to the total because of rounding.
Sources: Investment Company Institute, Federal Reserve Board, Department of Labor, National Association of Government Defined Contribution Administrators, American Council of Life Insurers, and Internal Revenue Service Statistics of Income Division. See “The U.S. Retirement Market, Fourth Quarter 2012.”

Sixty-eight percent of U.S. households (or 82 million households) reported that they had employer-sponsored retirement plans, IRAs, or both in May 2012 (Figure 7.5). Sixty percent of U.S. households reported that they had employer-sponsored retirement plans—that is, they had assets in DC plan accounts, were receiving or expecting to receive benefits from DB plans, or both. Forty percent of households reported having assets in IRAs, and 32 percent of households had both IRAs and employer-sponsored retirement plans.

Figure 7.5

Many U.S. Households Have Tax-Advantaged Retirement Savings

Percentage of U.S. households, May 2012

Figure 7.5

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1IRAs include traditional IRAs, Roth IRAs, and employer-sponsored IRAs (SEP IRAs, SAR-SEP IRAs, and SIMPLE IRAs).
2Employer-sponsored retirement plans include DC and DB retirement plans.
Sources: Investment Company Institute and U.S. Census Bureau. See ICI Research Perspective, “The Role of IRAs in U.S. Households’ Saving for Retirement, 2012.”

Ownership of IRA and DC plan assets tends to become more common with each successive generation of workers. This can be seen by comparing the ownership rates of households grouped by the decade in which the household heads were born (Figure 7.6). At any given age, more recent birth cohorts tend to have higher IRA and DC plan account ownership rates over time. For example, in 2012, when they were 43 to 52 years of age, 73 percent of households born in the 1960s owned IRAs or DC plan accounts. By comparison, households born a decade earlier had a 70 percent ownership rate when they were 43 to 52 in 2002. And, among households born in the 1940s, 58 percent had IRAs or DC plan accounts when they were 43 to 52 in 1992.

Figure 7.6

Younger Households Tend to Have Higher Rates of IRA or Defined Contribution Plan Ownership

Percentage of U.S. households owning IRAs or DC plans by decade in which household heads were born, 1983–2012

Figure 7.6

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Note: Age is the average age of the 10-year birth cohort at the time of the survey. The 10-year birth cohorts are defined using the age of the head of household. Data from 2000 to 2012 are from annual household surveys conducted by ICI. Growth for the period 1983 to 2000 is estimated using the Federal Reserve Board Survey of Consumer Finances.
Sources: ICI Annual Mutual Fund Shareholder Tracking Surveys and ICI tabulations of Federal Reserve Board Survey of Consumer Finances

Defined Contribution Retirement Plans

DC plans provide employees with a retirement account derived from employer or employee contributions or both, plus investment earnings or losses on those contributions, less withdrawals from the plans. Assets in employer-sponsored DC plans have grown more rapidly than assets in other types of employer-sponsored retirement plans over the past quarter century, increasing from 27 percent of employer plan assets in 1985 to 41 percent at year-end 2012. At the end of 2012, employer-sponsored DC plans—which include 401(k) plans, 403(b) plans, 457 plans, Keoghs, and other DC plans—held an estimated $5.1 trillion in assets (Figure 7.7). With $3.6 trillion in assets at year-end 2012, 401(k) plans held the largest share of employer-sponsored DC 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 $1.0 trillion in assets. The remaining $485 billion in DC plan assets was held by other DC plans without 401(k) features.

Figure 7.7

Defined Contribution Plan Assets by Type of Plan

Billions of dollars, year-end, selected years

Figure 7.7

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* Other DC plans include Keoghs and other DC 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, Department of Labor, National Association of Government Defined Contribution Administrators, and American Council of Life Insurers

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

Asset Allocation

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

On average, younger participants allocate a larger portion of their portfolios to equities (which include equity mutual funds and other pooled equity investments; the equity portion of balanced funds, including target date funds; and company stock of their employers). According to research conducted by ICI and the Employee Benefit Research Institute (EBRI), at year-end 2011, individuals in their twenties invested 39 percent of their assets in equity funds and company stock; 43 percent in target date funds and non–target date balanced funds; and only 14 percent in guaranteed investment contracts (GICs), stable value funds, money funds, and bond funds (Figure 7.8). All told, participants in their twenties had 74 percent of their 401(k) assets in equities. By comparison, at year-end 2011, individuals in their sixties invested 38 percent of their 401(k) account assets in GICs, stable value funds, money funds, and bond funds; only 18 percent in target date funds and non–target date balanced funds; and 39 percent in equity funds and company stock. All told, participants in their sixties had 48 percent of their 401(k) assets in equities.

Figure 7.8

401(k) Asset Allocation Varied with Participant Age

Average asset allocation of 401(k) account balances, percentage of assets, year-end 2011

Figure 7.8

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Note: Funds include mutual funds, bank collective trusts, life insurance separate accounts, and any pooled investment product primarily invested in the security indicated. Percentages are dollar-weighted averages. Components may not add to 100 percent because of rounding.
Source: Tabulations from EBRI/ICI Participant-Directed Retirement Plan Data Collection Project. See ICI Research Perspective, “401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2011.”

Within age groups, however, 401(k) portfolio allocation varies widely. For example, at year-end 2011, 62 percent of 401(k) participants in their twenties held more than 80 percent of their account in equities and 11 percent held 20 percent or less (Figure 7.9). Of 401(k) participants in their sixties, 21 percent held more than 80 percent of their account in equities and 24 percent held 20 percent or less.

Figure 7.9

Asset Allocation to Equities Varied Widely Among 401(k) Plan Participants

Asset allocation distribution of 401(k) participant account balance to equities, percentage of participants, year-end 2011

Figure 7.9

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Note: Equities include equity funds, company stock, and the equity portion of balanced funds. Funds include mutual funds, bank collective trusts, life insurance separate accounts, and any pooled investment product primarily invested in the security indicated.
Source: Tabulations from EBRI/ICI Participant-Directed Retirement Plan Data Collection Project. See ICI Research Perspective, “401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2011.”

Target Date Funds

Target date funds, which were introduced in the mid-1990s, have grown rapidly in recent years. A target date fund (including both target date mutual funds and other pooled target date investments) follows a predetermined reallocation of assets over time based on a specified target retirement date. Typically the fund rebalances its portfolio to become less focused on growth and more focused on income as it approaches and passes the target date, which is usually indicated in the fund’s name. There has been an increase in the share of 401(k) plans that offer target date funds, the share of 401(k) plan participants who are offered target date funds, and the share of 401(k) participants who invest in target date funds (Figure 7.10). At year-end 2011, target date fund assets represented 13 percent of total 401(k) assets, up from 11 percent at year-end 2010 and 5 percent at year-end 2006.

Figure 7.10

Target Date Funds’ 401(k) Market Share

Percentage of total 401(k) market, year-end, 2006–2011

Figure 7.10

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Note: Funds include mutual funds, bank collective trusts, life insurance separate accounts, and pooled investment products.
Source: Tabulations from EBRI/ICI Participant-Directed Retirement Plan Data Collection Project. See ICI Research Perspective, “401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2011.”

In 2011, 72 percent of 401(k) plans offered target date funds, and 68 percent of 401(k) plan participants were offered target date funds (Figure 7.10). Because not all plan participants choose to allocate assets to the funds, the percentage of 401(k) participants with target date fund assets was lower than the percentage of participants who were offered the option. At year-end 2011, 39 percent of 401(k) participants held at least some plan assets in target date funds. In addition, because not all participants with assets in the funds allocated 100 percent of their holdings to the funds, and because participants with assets in the funds were more likely to be younger or recently hired and have lower account balances, the share of 401(k) assets invested in target date funds was lower than the share of participants invested in the funds.

Account Balances

Account balances tended to be higher the longer 401(k) plan participants had been working for their current employers and the older the participant. Participants in their sixties with more than 30 years of tenure at their current employers had an average 401(k) account balance of $208,892 (Figure 7.11). The median age of 401(k) plan participants was 45 years at year-end 2011, and the median job tenure was eight years. Participants in their forties with five to 10 years of tenure at their current employers had an average 401(k) balance of $48,899 at year-end 2011.

FIGURE 7.11

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

Average 401(k) participant account balance, year-end 2011

Figure 7.11

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Source: Tabulations from EBRI/ICI Participant-Directed Retirement Plan Data Collection Project. See ICI Research Perspective, “401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2011.”

Plan Loans

Most 401(k) participants do not borrow from their plans, although loan activity has edged up in recent years. At year-end 2011, 21 percent of those eligible for loans had loans outstanding. However, not all participants have access to 401(k) plan loans—factoring in all 401(k) participants with and without loan access in the EBRI/ICI 401(k) database, only 18 percent had loans outstanding at year-end 2011. The average unpaid loan balance among participants with loans represented about 14 percent of their 401(k) account balances (net of the unpaid loan balances). In aggregate, Department of Labor data indicate that outstanding loan amounts were less than 2 percent of 401(k) plan assets in 2010.

Services and Expenses in 401(k) Plans

Employers are confronted with two competing economic pressures: the need to attract and retain quality workers with competitive compensation packages and the need to keep their products and services competitively priced. In deciding whether 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.

To provide and maintain 401(k) plans, employers are required to obtain a variety of administrative, participant-focused, regulatory, and compliance services. 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), directly by the plan participants (i.e., the employees), indirectly by the participants through fees or other reductions in returns paid to the investment provider, or by some combination of these methods (Figure 7.12).

Figure 7.12

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

Figure 7.12

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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: ICI Research Perspective, “The Economics of Providing 401(k) Plans: Services, Fees, and Expenses, 2010”

One key driver of 401(k) plan fees is plan size. A Deloitte/ICI study of 525 DC plans in 2011 created and analyzed a comprehensive plan fee measure, the “all-in fee.” The study found that plans with more participants and larger average account balances tended to have lower all-in fees than plans with fewer participants and smaller average account balances. This observed effect likely results in part from fixed costs required to start up and run the plan, much of which are driven by legal and regulatory requirements. It appears that economies of scale are gained as a plan grows in size because these fixed costs can be spread over more participants or a larger asset base or both. In addition, plans with higher participant contribution rates or automatic enrollment tended to have lower all-in fees. Plans with a higher percentage of their assets in equity investments tended to have higher all-in fees, reflecting the higher expense ratios associated with equity investing compared with fixed-income investing. Plans with a higher number of investment options also tended to have higher all-in fees. The study also examined the type of service provider or variables relating to the plan’s relationship with the service provider, but found little impact on fees.

Participants in 401(k) plans holding mutual funds tend to invest in lower-cost funds and 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 2011, 33 percent of 401(k) equity mutual fund assets were in funds that had total annual expense ratios below 0.50 percent of fund assets, and another 49 percent had expense ratios between 0.50 percent and 1.00 percent (Figure 7.13). On an asset-weighted basis, the average total expense ratio incurred on 401(k) participants’ holdings of equity mutual funds through their 401(k) plans was 0.65 percent in 2011 compared with an asset-weighted average total expense ratio of 0.79 percent for equity mutual funds industrywide. Similarly, equity mutual funds held in 401(k) accounts tend to have lower turnover in their portfolios. The asset-weighted average turnover rate of equity funds held in 401(k) accounts was 42 percent in 2011, compared with an industrywide asset-weighted average of 52 percent. Sixty percent of 401(k) assets at year-end 2012 were invested in mutual funds.

Figure 7.13

401(k) Equity Mutual Fund Assets Are Concentrated in Lower-Cost Funds

Percentage of 401(k) equity mutual fund assets, year-end 2011

Figure 7.13

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* The total expense ratio, which is reported as a percentage of fund assets, includes fund operating expenses and the 12b-1 fee.
Note: The figure excludes mutual funds available as investment choices in variable annuities. Components do not add to 100 percent because of rounding.
Sources: Investment Company Institute and Lipper

Individual Retirement Accounts

Traditional IRAs, the first type of IRA, were designed with two goals when they were created in 1974 under the Employee Retirement Income Security Act (ERISA). First, they provide individuals not covered by workplace retirement plans with an opportunity to save for retirement on a tax-advantaged basis on their own. Second, they allow workers who are leaving jobs a means to preserve the tax benefits and growth opportunities that employer-sponsored retirement plans provide. Policymakers have subsequently added other types of IRAs—employer-sponsored IRAs (SEP IRAs, SAR-SEP IRAs, and SIMPLE IRAs) and after-tax IRAs (Roth IRAs).

Total IRA assets were $5.4 trillion at year-end 2012 and accounted for 28 percent of U.S. retirement assets. Mutual fund assets held in IRAs were $2.5 trillion at year-end 2012, up from year-end 2011 (Figure 7.14). Assets managed by mutual funds were the largest component of IRA assets, followed by other assets, including ETFs, individual stocks and bonds, and other securities held through brokerage accounts ($2.1 trillion at year-end 2012). The mutual fund industry’s share of the IRA market was 46 percent at year-end 2012, compared with 45 percent at year-end 2011.

FIGURE 7.14

IRA Assets

Billions of dollars, year-end, selected years

Figure 7.14

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1Category excludes mutual fund assets held through brokerage accounts, which are included in mutual funds.
2Life insurance company IRA assets are annuities held by IRAs, excluding variable annuity mutual fund IRA assets, which are included in mutual funds.
3Bank and thrift deposits include Keogh deposits.
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. See “The U.S. Retirement Market, Fourth Quarter 2012.”

IRA Investors

Four out of 10, or 49 million, U.S. households owned at least one type of IRA as of mid-2012 (Figure 7.15). Traditional IRAs—defined as those IRAs first allowed under ERISA—were the most common type of IRA, owned by 39 million U.S. households. Roth IRAs, first made available in 1998 under the Taxpayer Relief Act of 1997, were owned by 20 million U.S. households in mid-2012. Nine million U.S. households owned employer-sponsored IRAs (SEP IRAs, SAR-SEP IRAs, or SIMPLE IRAs).

Although most U.S. households are eligible to make contributions to IRAs, few do so. For example, only 16 percent of U.S. households contributed to any type of IRA in tax year 2011. In addition, very few eligible households made “catch-up” contributions to traditional or Roth IRAs.

Figure 7.15

49 Million U.S. Households Owned IRAs

May 2012

  Year created Number of U.S.
households
with type of IRA
Percentage of U.S.
households
with type of IRA
Traditional IRA 1974
(Employee Retirement Income Security Act)
39.4 million 32.5%
SEP IRA 1978
(Revenue Act)
9.2 million 7.6%
SAR-SEP IRA 1986
(Tax Reform Act)
SIMPLE IRA 1996
(Small Business Job Protection Act)
Roth IRA 1997
(Taxpayer Relief Act)
20.3 million 16.8%
Any IRA   48.9 million 40.4%

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Note: Households may own more than one type of IRA. SEP IRAs, SAR-SEP IRAs, and SIMPLE IRAs are employer-sponsored IRAs.
Sources: Investment Company Institute and U.S. Census Bureau. See ICI Research Perspective, “The Role of IRAs in U.S. Households’ Saving for Retirement, 2012.”

Instead, investment returns and rollovers from employer-sponsored retirement plans have fueled the growth of IRAs. In any given year, a small portion of traditional IRA investors make rollovers, but analysis of The IRA Investor Database finds that, for the most part, different groups make rollovers year-to-year. For example, of investors with traditional IRAs at year-end 2011, nearly 36 percent had made rollovers between 2007 and 2011, with 9 percent making rollovers in 2011 (Figure 7.16). The proportion of IRA owners that have ever made a rollover is higher because typically different investors make rollovers each year. Of U.S. households owning traditional IRAs in May 2012, an ICI household survey found that 51 percent (or 20 million U.S. households) had traditional IRAs that included rollover assets (Figure 7.17). Among traditional IRA–owning households with rollovers, 27 percent had rolled over recently (since 2010), while for 21 percent their most recent rollover occurred before 2000. In their most recent rollover, the vast majority of these households (80 percent) transferred their entire retirement plan balances into traditional IRAs.

Figure 7.16

Rollover Activity in The IRA Investor Database™

Percentage of traditional IRA investors aged 25 to 74, year-end 2011

Figure 7.16

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Source: The IRA Investor Database™


Figure 7.17

Rollovers Are Often a Source of Assets for Traditional IRA Investors

Figure 7.17

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Source: ICI Research Perspective, “The Role of IRAs in U.S. Households’ Saving for Retirement, 2012”

Households owning IRAs generally are headed by middle-aged individuals (median age 52 years) with moderate household incomes (median income $75,000). These households held a median of $45,000 in IRAs. In addition, many households held multiple types of IRAs. For example, 35 percent of households with traditional IRAs also owned Roth IRAs, and 15 percent also owned employer-sponsored IRAs.

IRA Investors’ IRA Portfolios

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 7.18). Sixty-eight percent of IRA-owning households had IRA assets invested in mutual funds. About four out of five of these households—or 55 percent of all IRA-owning households—held at least a portion of their IRA balance in equity mutual funds. Fewer households owned other types of investments in their IRAs: 41 percent held individual equities, 35 percent held annuities, and 25 percent held bank deposits.

Figure 7.18

Households Invested Their IRAs in Many Types of Assets

Percentage of U.S. households owning IRAs, May 2012

Mutual funds (total) 68
    Equity mutual funds 55
    Bond mutual funds 35
    Hybrid mutual funds 31
    Money market funds 31
Individual equities 41
Annuities (total) 35
    Fixed annuities 24
    Variable annuities 22
Bank savings accounts, money market deposit accounts, or certificates of deposit 25
Individual bonds (not including U.S. savings bonds) 15
U.S. savings bonds 12
ETFs 10
Other 3

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Note: Multiple responses are included.
Source: ICI Research Perspective, “Appendix: Additional Data on IRA Ownership in 2012”

Younger IRA investors tended to have more invested in equities, equity funds, and target date funds, on average, than older investors according to data in The IRA Investor Database. Data for year-end 2011 show that older investors were more heavily invested in non–target date hybrid funds and fixed-income investments. For example, traditional IRA investors in their thirties had, on average, more than 50 percent of their assets invested in equities and equity funds and another 16 percent in target date funds (Figure 7.19). Investors in their sixties held 46 percent and 4 percent of their traditional IRA assets, respectively, in these two asset categories. In contrast, traditional IRA investors in their sixties had nearly half of their assets invested in money market funds (14 percent), bonds and bond funds (22 percent), and non–target date hybrid funds (11 percent). Investors in their thirties held 29 percent of their assets in these three asset categories.

Figure 7.19

Traditional IRA Asset Allocation Varied with Investor Age

Average asset allocation of traditional IRA balances, percentage of assets, year-end 2011

Figure 7.19

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1Other investments include certificates of deposit and unidentifiable assets.
2Equity funds include equity mutual funds, equity closed-end funds, and equity ETFs.
3A target date (also known as lifecycle) mutual fund typically rebalances its portfolio to become less focused on growth and more focused on income as it approaches and passes the target date of the fund, which is usually included in the fund’s name.
4Hybrid funds invest in a mix of equities and fixed-income securities.
5Bond funds include bond mutual funds, bond closed-end funds, and bond ETFs.
Note: Percentages are dollar-weighted averages. Components may not add to 100 percent because of rounding.
Source: The IRA Investor Database™

Distributions from Traditional IRAs

Of households with traditional IRAs in May 2012, 21 percent took withdrawals in tax year 2011 (Figure 7.20). Withdrawals from traditional IRAs were typically modest: the median withdrawal in tax year 2011 was $7,000 and 37 percent of withdrawals totaled less than $5,000. The median ratio of withdrawals to account balances was 8 percent.

Often, withdrawals from traditional IRAs were taken to fulfill required minimum distributions (RMDs). An RMD is a distribution equal to a percentage of the IRA account balance, with the percentage based on remaining life expectancy. Traditional IRA owners aged 70½ or older must withdraw the minimum amount each year or pay a penalty for failing to do so. In tax year 2011, 65 percent of individuals who took traditional IRA withdrawals stated they did so to comply with RMD rules.

Figure 7.20

Withdrawals from Traditional IRAs Are Infrequent

Figure 7.20

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1The household was considered retired if either the head of household or spouse responded affirmatively to the question: “Are you retired from your lifetime occupation?”
2Households that made withdrawals exclude those that closed and no longer own traditional IRAs.
Source: ICI Research Perspective, “The Role of IRAs in U.S. Households’ Saving for Retirement, 2012”

Of the 21 percent of traditional IRA–owning households in 2012 who reported taking withdrawals in tax year 2011, 76 percent reported that the head of household or the spouse or both were retired (Figure 7.20). Of retired households that took traditional IRA withdrawals in tax year 2011, 35 percent reported using some or all of the funds to pay for living expenses (Figure 7.21). Other uses included reinvesting or saving the withdrawal amount in another account (32 percent), using the withdrawal for a healthcare expense (15 percent), and using the withdrawal for a home purchase, repair, or remodeling (16 percent). The remaining 24 percent of traditional IRA–owning households who reported taking withdrawals in tax year 2011 were not retired, and they indicated a slightly different pattern of uses for the withdrawals. The nonretired households with withdrawals were less likely to indicate using some or all of the monies for living expenses (22 percent) than the retired households (35 percent). The nonretired households were much more likely to indicate they needed to use some or all of the withdrawal for an emergency (17 percent) or for home purchase, repair, or remodeling (21 percent). Nine percent of nonretired households with withdrawals indicated they used some or all of the money to pay for educational expenses.

Figure 7.21

Traditional IRA Withdrawals Among Retirees Are Often Used to Pay for Living Expenses

Percentage of traditional IRA–owning households by retirement status,1 May 2012

  Retired1, 2 Not retired3
Use of traditional IRA withdrawal
Took withdrawals to pay for living expenses 35 22
Spent it on a car, boat, or big-ticket item other than a home 9 3
Spent it on a healthcare expense 15 11
Used it for an emergency 7 17
Used it for home purchase, repair, or remodeling 16 21
Reinvested or saved it in another account 32 12
Paid for education 4 9
Some other use 16 9

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1The household was considered retired if either the head of household or spouse responded affirmatively to the question: “Are you retired from your lifetime occupation?”
2The base of respondents includes the 16 percent of traditional IRA–owning households that were retired and took withdrawals reported in Figure 7.20.
3The base of respondents includes the 5 percent of traditional IRA–owning households that were not retired and took withdrawals reported in Figure 7.20.
Note: Multiple responses are included.
Source: ICI IRA Owners Survey. See ICI Research Perspective, “The Role of IRAs in U.S. Households’ Saving for Retirement, 2012.”

Because current withdrawal activity may not be a good indicator of future withdrawal activity, ICI also asked about plans for future traditional IRA withdrawals. Among traditional IRA–owning households in 2012 that did not take a withdrawal in tax year 2011, 65 percent said that they were not likely to take a withdrawal before age 70½. Traditional IRA–owning households that were either (1) retired but did not take withdrawals in tax year 2011 or (2) not retired reported a pattern for the expected role of future IRA withdrawals in retirement that is consistent with the use of withdrawals among those who withdrew in tax year 2011. Sixty-three percent of these households reported they plan to use IRA withdrawals to pay for living expenses in retirement and 62 percent reported they plan to use IRA withdrawals for an emergency.

The Role of Mutual Funds in Households’ Retirement Savings

At year-end 2012, mutual funds held in DC plans and IRAs accounted for $5.3 trillion, or 27 percent, of the $19.5 trillion U.S. retirement market. The $5.3 trillion in mutual fund retirement assets represented 41 percent of all mutual fund assets at year-end 2012. Retirement savings accounts were a significant portion of long-term mutual fund assets industrywide (48 percent), but were a relatively minor share of money market fund assets industrywide (14 percent). Similarly, as a share of households’ mutual fund holdings, mutual fund assets held in DC plans and IRAs represented 51 percent of household long-term mutual funds, but only 21 percent of household money market funds (Figure 7.22).

Figure 7.22

Households’ Mutual Fund Assets by Type of Account

Billions of dollars, year-end 2012

Figure 7.22

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1Mutual funds held as investments in 529 plans and Coverdell ESAs are counted in this category.
2IRAs include traditional IRAs, Roth IRAs, and employer-sponsored IRAs (SEP IRAs, SAR-SEP IRAs, and SIMPLE IRAs).
3DC plans include 401(k) plans, 403(b) plans, 457 plans, Keoghs, and other DC plans without 401(k) features.
Note: Components may not add to the total because of rounding.

Within the total U.S. retirement market, mutual funds play a significant role in IRAs and employer-sponsored DC plans such as 401(k) plans. At year-end 2012, investors held slightly more mutual fund assets in DC plans ($2.9 trillion or 57 percent of total DC plan assets) than they held in IRAs ($2.5 trillion, or 46 percent of total IRA assets) (Figure 7.23). Among DC plans, 401(k) plans were the largest holder of mutual funds, with $2.1 trillion in assets. At year-end 2012, 403(b) plans held $383 billion in mutual fund assets, 457 plans held $88 billion, and other DC plans held $262 billion.

Types of Mutual Funds Used by Retirement Plan Investors

Retirement investors tend to hold equity investments. Fifty-three percent of the $5.3 trillion in mutual fund retirement assets held in DC plans and IRAs at year-end 2012 was invested in domestic or world equity funds (Figure 7.23). By comparison, about 45 percent of overall fund industry assets—including retirement and nonretirement accounts—were invested in domestic or world equity funds at year-end 2012. Domestic equity funds alone constituted about $2.2 trillion, or 40 percent, of mutual fund assets held in DC plans and IRAs.

Retirement investors also gain exposure to equities and fixed-income securities through hybrid funds. At year-end 2012, 22 percent of mutual fund assets held in DC plans and IRAs were held in hybrid funds, which invest in a mix of equity, bond, and money market securities (Figure 7.23). At year-end 2012, the remaining 25 percent of mutual fund assets held in DC plans and IRAs were invested in bond funds and money market funds. Bond funds held $933 billion, or 17 percent, of mutual fund assets held in DC plans and IRAs, and money market funds accounted for $379 billion, or 7 percent.

Figure 7.23

Bulk of Mutual Fund Retirement Account Assets Was Invested in Equities

Billions of dollars, year-end 2012

  Equity  
Domestic World Hybrid1 Bond Money market Total
IRAs2 $932 $318 $513 $486 $224 $2,473
DC plans 1,227 373 673 447 156 2,875
   401(k) plans 875 298 552 314 104 2,143
   403(b) plans 221 32 65 43 22 383
   457 plans 40 11 18 17 1 88
   Other DC plans3 91 31 38 73 29 262
Total 2,159 690 1,186 933 379 5,348

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1Hybrid funds invest in a mix of equities and fixed-income securities. The bulk of target date and lifestyle funds is counted in this category.
2IRAs include traditional IRAs, Roth IRAs, and employer-sponsored IRAs (SEP IRAs, SAR-SEP IRAs, and SIMPLE IRAs).
3Other DC plans include Keoghs and other DC plans without 401(k) features.
Note: Components may not add to the total because of rounding.

Target Date and Lifestyle Mutual Funds

Target date and lifestyle mutual funds, generally included in the hybrid fund category, have grown in popularity among investors and retirement plan sponsors over the past decade. A target date fund follows a predetermined reallocation of assets over time based on a specified target retirement date. Typically the fund rebalances its portfolio to become less focused on growth and more focused on income as it approaches and passes the target date, which is usually indicated in the fund’s name. A lifestyle fund maintains a predetermined risk level and generally uses words such as “conservative,” “moderate,” or “aggressive” in its name to indicate the fund’s risk level. Assets in target date and lifestyle mutual funds totaled $773 billion at the end of 2012 (Figure 7.24), up from $638 billion at year-end 2011. Target date mutual funds’ assets were up 28 percent in 2012, increasing from $376 billion to $481 billion. Assets of lifestyle mutual funds increased in 2012, rising from $262 billion to $292 billion. The bulk (91 percent) of target date mutual fund assets was held in retirement accounts, compared with 42 percent of lifestyle mutual fund assets.

The Role of Mutual Funds in Households’ Education Savings

Twenty-seven percent of households that owned mutual funds in 2012 cited 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 the Economic Growth and Tax Relief Reconciliation Act (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 Pension Protection Act (PPA) in 2006 made the EGTRRA enhancements to Section 529 plans permanent. The enactment of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended the EGTRRA enhancements to Coverdell ESAs for two years, and they were made permanent by the American Taxpayer Relief Act of 2012.

Figure 7.24

Target Date and Lifestyle Mutual Fund Assets by Account Type

Billions of dollars, year-end, 2002–2012

Figure 7.24

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1IRAs include traditional IRAs, Roth IRAs, and employer-sponsored IRAs (SEP IRAs, SAR-SEP IRAs, and SIMPLE IRAs).
2DC plans include 401(k) plans, 403(b) plans, 457 plans, Keoghs, and other DC plans without 401(k) features.
3A target date mutual fund typically rebalances its portfolio to become less focused on growth and more focused on income as it approaches and passes the target date of the fund, which is usually included in the fund’s name.
4A lifestyle mutual fund maintains a predetermined risk level and generally contains “conservative,” “moderate,” or “aggressive” in the fund’s name.
Note: Components may not add to the total because of rounding.

Assets in Section 529 savings plans increased 17 percent in 2012, with $168.9 billion in assets at the end of 2012, up from $144.9 billion at year-end 2011 (Figure 7.25). As of year-end 2012, the number of accounts was 9.9 million, and the average account size was approximately $17,100.

Figure 7.25

Section 529 Savings Plan Assets

Billions of dollars, year-end, 2001–2012

Figure 7.25

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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, College Savings Plans Network, College Savings Foundation, and Financial Research Corporation

In 2012, as a group, households saving for college through 529 plans, Coverdell ESAs, or mutual funds held outside of these accounts tended to be headed by younger individuals, with 55 percent younger than 45 (Figure 7.26). Heads of households saving for college had a range of educational attainment: 46 percent had less than four years of college education and 54 percent had four years of college or more. In addition, these households represented a range of incomes: 36 percent had household income less than $75,000; 20 percent earned between $75,000 and $99,999; and 44 percent had household incomes of $100,000 or more. Two-thirds of these households had children (younger than 18) in the home and 43 percent had more than one child in the home.

Figure 7.26

Characteristics of Households Saving for College

Percentage of U.S. households saving for college,1 May 2012

Age of head of household2
Younger than 35 26
35 to 44 29
45 to 54 24
55 to 64 12
65 or older 9
Education level
High school graduate or less 20
Associate’s degree or some college 26
Completed college 22
Some graduate school or completed graduate school 32
Household income3
Less than $25,000 4
$25,000 to $34,999 6
$35,000 to $49,999 9
$50,000 to $74,999 17
$75,000 to $99,999 20
$100,000 or more 44
Number of children in home4
None 33
One 24
Two 29
Three or more 14

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1Households saving for college are households that own education savings plans (Coverdell ESAs or 529 plans) or responded that paying for education was one of their financial goals for their mutual funds.
2Age is based on the sole or co-decisionmaker for saving and investing.
3Total reported is household income before taxes in 2011.
4The number of children reported is children younger than 18 living in the home.

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