There’s more than one way to save for retirement, and choosing the right strategy for you will partly depend on your age when you begin stashing money away for your golden years. For young workers—millennials and members of Gen Z—most financial experts agree that a Roth IRA is a smart move as it provides an effective way to save throughout your career and then make tax-free withdrawals after leaving the workforce.

If you’re considering a Roth IRA, the forthcoming content is for you. In this guide, we’ll run through some need-to-know information about this type of retirement savings account including what it is, how it works, and why it makes sense for many millennial and Gen-Z workers. Let’s dive in.

What is a Roth IRA?

So, just what is a Roth IRA, anyway? The IRA piece stands for “individual retirement account.” In other words, this long-term account is designed specifically for your retirement and is not a rainy-day savings fund.

In putting after-tax dollars into your Roth IRA, know that this “after-tax” bit is crucial and diverges from traditional IRAs: which are taxed at withdrawal, meaning account holders often wind up paying a significant chunk of cash at a time when they need all the money they can get.

Traditional IRAs do have their own tax benefits—which are generally lost on younger workers—and as millennial and Gen-Z workers are just launching their careers, they typically earn less than they will in subsequent years and consequently fall into a lower tax bracket.

Note that Roth IRA funds are still taxed, but no tax is paid upon withdrawing the money in retirement; it all essentially boils down to paying taxes now but enjoying decades of tax-free growth and income during retirement rather than potentially paying higher taxes at that time.

How a Roth IRA works

First and foremost, you’ll need a source of income to open a Roth IRA—but the process itself is pretty simple. While most people contribute to their Roth IRA directly from their net pay, you can also fund the account from a host of other sources such as a spousal contribution or an existing 401(k) or traditional IRA.

As of 2023, you can contribute up to $6,500 to your Roth IRA on an annual basis (with this figure rising to $7,000 in 2024). For any low-income earners out there—such as part-time workers—know that your contributions cannot exceed your earned income. Thus, if you earn $5,000 a year, the most you contribute to a Roth IRA during that same tax year is also $5,000. You can, however, contribute as much as you want (up to the limit) and whenever you want (monthly, quarterly, if extra money frees up, etc.).

Once your Roth IRA is established, you’ll need to consider underlying Roth IRA investments (knowing you can invest in many different types of assets within the account including stocks, bonds, ETFs, and mutual funds). As with all investments, Roth IRAs do include some element of risk—with some investments more risky than others. It’s therefore essential to ensure your investments are allocated according to your risk tolerance.

Financial challenges for millennials and Gen-Z workers

As hinted at earlier, the number of millennials and Gen-Z workers who have opened Roth IRAs in recent years has skyrocketed—according to a recent Fidelity Investments report—and that’s no coincidence. It’s no secret that younger generations of workers face various financial challenges, and as such, many are considering their retirement savings options earlier than previous generations. Some key issues confronting millennials and Gen Z that ultimately impact their financial standing include:

Rising home prices
Thanks to the growing cost of home ownership, it’s now more challenging than ever for young adults to own property: an action that not only fosters a good quality of life but also helps fortify the financial landscape for individuals.

Rising rent costs
Unable to buy a home, many millennials and Gen Zers are locked into renting; and with rent costs spiraling out of control, many young people can’t build up their savings in the process.

High cost of living
Increasing expenses on a macro scale hit young people in two ways. First, they need to allocate more of their paycheck to the essentials: making it difficult to save. Second, they’ll need even more money to enjoy a comfortable retirement in the future.

Mounting student debt
Millennials and Gen Zers were forced to contend with soaring tuition costs—which have doubled since the 1980s—and many are thus buried under expensive college debt payments.

Employment insecurity
A job is no longer for life. With employment instability and underemployment an ongoing concern, many young people remain unsure about how exactly to fund their retirement.

Roth IRAs: a viable solution for many millennials and Gen-Z investors

Opening a Roth IRA will not automatically make all the afore-mentioned financial issues disappear, but it can help ease the stress of those concerns in the long run. After all, these investments offer a range of benefits that can help improve the financial landscape for these younger generations on both a medium- and long-term basis.

For example, one handy exception to early withdrawal penalties (more on that below) is using that money to buy or build a home. Roth IRA account holders can withdraw up to $10,000 for this very purpose, making it a little easier to purchase a property.

The real value of a Roth IRA is seen in retirement, however. Faced with generational financial challenges, young workers may find it difficult to create a sizable nest egg for their golden years. Making even a small monthly contribution to their Roth IRA can help breed a large sum of money to live on during retirement, primarily due to two reasons: time (with contributions made over decades) and compound interest (the money can build on itself).

These benefits are available to everyone but especially advantageous for young workers. Why? Because this age demographic will likely move up into a higher tax bracket as they progress in their careers and earn a higher salary. As Roth IRAs are comprised of pre-tax money and those in their twenties and thirties are (likely) taxed at a lower rate, millennial and Gen-Z workers can potentially save more on taxes via a Roth IRA than a traditional IRA: keeping more of their money.

Roth IRA income limits

Roth IRAs are subject to salary limits, meaning that if you are single with a MAGI (modified adjusted gross income) exceeding $153,000, you cannot open a Roth IRA. You can, however, open a traditional IRA—which is not subject to the same. Single workers with a MAGI between $138,000 and $153,000, meanwhile, can contribute to a Roth IRA at a reduced rate.

Interested in filing jointly? The maximum MAGI limit is $228,000 based on contribution qualifications in this scenario, and if your joint MAGI falls between $218,000–$228,000, your maximum allowed annual contribution is reduced. High-income earners who exceed these thresholds can still contribute to a Roth IRA but must do so via an IRS-approved method referred to as a backdoor IRA.

Roth IRA penalties

Roth IRA withdrawal penalty rules vary based on age, amount withdrawn, and how long the account is open; but you can withdraw sums equivalent to contributions you’ve made both penalty and tax-free, anytime and for any reason. If you’re over age 59½ and want to withdraw from the earnings portion of the account, you can do so tax-free—provided you’ve owned the account for at least five years (known as the “five-year rule”). Withdraw from the earnings portion of your Roth IRA any earlier and you may face a 10% early withdrawal penalty as well as a requirement to pay taxes on this amount. That said, there are exceptions to every rule; Roth IRAs are no different.

For example, anyone who’s owned his or her Roth IRA for more than five years and is younger than 59½ can often avoid early withdrawal penalties and taxes in various scenarios including:

·      You use the withdrawal to fund a first-time home purchase (up to $10,000)

·      An estate or beneficiary withdraws the money after your death (if you’ve held the account for less than five years)

If you’ve had your Roth IRA for less than five years and are younger than 59½, you can avoid the early withdrawal penalty but are still subject to taxes if:

·      You use the withdrawal to cover unreimbursed medical expenses or health insurance if you’re unemployed

·      You use the withdrawal to pay for qualified education expenses

·      You use the withdrawal to fund a first-time home purchase (up to $10,000)

·      You use the funds for qualified expenses related to a birth or adoption

·      Your estate or beneficiary withdraws the money after your death (if you’ve held the account for less than five years)

·      You make the distribution in substantially equal periodic payments (otherwise known as a “SEPP”)

Note that the new SECURE Act 2.0 plans to expand these circumstances to include emergency expenses and domestic abuse. Finally, if you’re age 59½ or older and have owned your Roth IRA for less than five years, you’ll owe income tax but won’t need to pay a penalty on earnings you withdraw.

Roth IRA pros and cons

There’s no such thing as a perfect investment account, and the same holds true for Roth IRAs—which feature their own unique advantages and disadvantages.

Pros

Tax-free savings growth
You won’t pay any tax when you withdraw your money at retirement, which can result in significant savings—especially if you occupy a higher tax bracket at that time.

No RMD requirements
Required minimum distributions (RMDs) are a minimum withdrawal amount specified by the IRS for traditional IRAs. Roth IRAs, on the other hand, aren’t subject to any RMD rules—meaning you aren’t required to make any withdrawals at any point during your lifetime.

Flexible contribution withdrawals
There are penalties for early withdrawal of your earnings, but not to the contributions you made, so in effect, your Roth IRA contributions can function as an emergency savings fund.

Diversification
Roth IRAs offer a great way to diversify your retirement portfolio, ensuring all your accounts aren’t tax-deferred.

Cons

You still pay taxes
Roth IRAs are not exempt from tax altogether; the money you contribute has already been taxed. In essence, you’ll pay taxes now to protect the future you from doing so again.

You can’t contribute as much as you’d like
As mentioned earlier, strict limits keep individual contributions in check—diverging from other savings vehicles such as 401(k)s. Furthermore, you can’t withdraw from the earnings portion (without incurring a fee) before the age of 59½.

Roth IRAs: the bottom line

Roth IRAs aren’t suitable for everyone, but they do feature some unique advantages that make them ripe for millennial and Gen-Z consideration. If you’re looking to get a jump on your retirement savings efforts, consider opening a Roth IRA to reap the associated benefits.

Still have questions about Roth IRAs or how to invest your money? Schedule a FREE Discovery call with one of our financial advisors.

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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.