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Vanguard: Investors Could Get More Out of IRAs

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. I recently visited Vanguard, where I sat down with Maria Bruno, a senior investment analyst in Vanguard's investment strategy group. We discussed contribution trends among IRA investors.

Benz: Maria, thank you so much for being here.

Maria Bruno: Good to be here. Thank you.

Benz: I know you and your team have been looking at contribution trends among IRA investors, and you found some really interesting things. One thing that you found is that some people are maxing out their contributions, but some people actually aren't. So, let's talk about the trends there.

Bruno: What we're seeing, I think, is overall positive. We're starting to look at our IRA shareholders to see general trends around contributions and withdrawals. And … we decided to look at, are investors contributing the max? What we found is that over half of the investors are. So we think that's very positive.

Benz: So, in 2013, it's $5,500 and $6,500 for people over 50.

You noted that some people aren't taking note of the new contribution limits and also that people over 50 aren't taking advantage of those catch-up contributions that they're able to take.

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Bruno: We zeroed in on a couple of things. One is, when we looked at the percentage of contributors who are contributing the max, we saw a dip at age 50. So that made us wonder, are those individuals aware that they can take advantage of a catch-up provision--they can invest an extra thousand dollars? So, perhaps there's an awareness issue, and we can continue to get that education out to investors.

The other thing that we saw was that, the last time that the IRA contribution limits increased in 2008, we saw that investors basically sit at the same clip that they were at the prior year. So we saw about a 10% reduction in investors maxing out.

So, I think that's important in light of this year in that the contribution limits have gone up. We might be able to do a better job in educating investors that they can invest more this year.

Benz: And your advice to investors would be to figure out how much you can contribute, know those limits, and if you're in a position to max out those contributions, you absolutely should do so?

Bruno: Absolutely, yes.

Benz: How about the breakdown between Roth and traditional IRA contributions? People investing in Vanguard IRAs, how are they making that decision about whether to do Roth or traditional?

Bruno: Well, not surprisingly, we see a split of our shareholders having both the traditional and Roth, and I think we expect that, and actually we advocate that.

Benz: That tax diversification idea?

Bruno: Absolutely, yes. So, I think that's good.

What we are seeing, though, is since 2007 we are still seeing Roths becoming very popular. I think, in terms of contributions, about two-thirds of the contributions are going into Roth.

I think as Roth becomes more commonplace, the education awareness around Roth continues to increase, I think we'll continue to see that pace.

Benz: Roth isn't necessarily the best choice for everyone. For some people, the traditional IRA may, in fact, make more sense. But you say to just really look at it rather than reflexively reaching for one type of account or another.

Bruno: There are a couple of things. There are contribution limits on traditional IRAs in terms of whether or not the contribution would be tax-deductible. So anyone can contribute to a traditional IRA. It's just a matter of whether it's tax deductible or not.

The limits for Roth are higher. So that might play into [your decision] as well. But the notion is the whole current versus future tax expectations, and the ability for Roths to grow tax-free. Some of the additional benefits that they have might be appealing to investors, really at all ages, whether they are young investors or nearing retirement.

Benz: You also took a look at what happens to contributions once they come in the door. How do they actually get invested? You found that a portion of those new contributions sit in cash, at least for a time after the initial contribution.

Bruno: What we found that was interesting was, during that January to mid-April tax season period, we found that about 20% of the contributions were going into money market accounts.

That's probably not surprising, because it's seen as a parking lot--the notion that I've got to get that IRA contribution in, and I'll deal with it later.

Benz: I'll figure it out later.

Bruno: Yes. So I think that may be some investor behavior there. But that made us question why a money market account? If you think about a 401(k), for instance, and the default options there, balanced funds or target-retirement funds are qualified default investment options there. Is there an opportunity to do that on IRA side? So if you are going to park it somewhere, maybe park it in a balanced fund, so that you get proper asset allocation and diversification right off the bat.

Benz: Get the money working for you.

Bruno: Right, and there is no tax consequences for making the shift later, and if you don't get back to it, at least you are in a much better spot with the balanced fund, generally speaking, than you would be with a money market fund.

Benz: Interesting findings. Thank you so much for sharing them with us.

Bruno: Thank you.