Which IRA is which?

Young people know that they should be saving for retirement by socking away money in a tax-advantaged account,…

Young people know that they should be saving for retirement by socking away money in a tax-advantaged account, but there is still confusion over the options that are available.

Generation X and Y investors are aware of the tax benefits of individual retirement accounts, but most of them are still confused about the difference between a traditional IRA and a Roth IRA, according to a survey conducted in December by T. Rowe Price Group Inc.

The asset management firm surveyed 860 investors 21 to 50 who said that they have at least one investment account. The survey found that though 70% of the respondents described themselves as “very familiar” with IRAs and almost 80% said that they contributed to one, only about half correctly understood the tax difference between traditional and Roth IRAs.

Just 48% of those surveyed correctly cited the tax-deferred growth potential of traditional IRAs, and just 51% correctly cited the tax-free growth potential of a Roth IRA.

The respondents also are confused about the withdrawal restrictions on each. One-fifth said they think that they can make tax-deferred contributions to a Roth IRAs, when that is actually a benefit of the traditional IRA. In fact, contributions to Roth IRAs are subject to normal income taxes.

“The history of IRAs is complex enough to make most anyone’s head spin,” said Christine Fahlund, a senior financial planner at T. Rowe Price. “As eligibility rules and contribution limits changed over the years, it appears that it became more difficult for many investors to understand the distinctions among different types of IRA accounts and to choose the most appropriate one for their circumstances.”