Why Roth IRAs Make Sense for Millennials

People tend to be in a lower tax bracket when they are younger than when they are in retirement, which is one reason why Roth individual retirement accounts (IRAs) are ideal for Millennials.

Roth IRAs don’t get the same up-front tax break that traditional IRAs do. But the holder of a Roth won’t owe taxes on any earnings in the account, or on qualified distributions. For Millennials and other young investors, that can mean decades of tax-free growth and then tax-free income during retirement.

The sooner you start building your nest egg, the better chance that you’ll have enough saved for a comfortable retirement. A great way to start saving early is with a Roth IRA.

Benefits of a Roth IRA

One of the best ways to save for retirement is with a Roth IRA. These tax-advantaged accounts offer many benefits:

• You don’t get an up-front tax break (like you do with traditional IRAs), but your contributions and earnings grow tax-free.
• Withdrawals during retirement are tax-free.
• There are no required minimum distributions (RMDs) during your lifetime, which makes Roth IRAs ideal wealth transfer vehicles.
• You can contribute at any age, as long as you have earned income and don’t make too much money.
  
• If you make too much money to contribute directly, you can legally get around those limits with a backdoor Roth IRA.
• If you contribute to a Roth IRA (or a traditional IRA), you may be eligible for the Saver’s Tax Credit, which can shave as much as $1,000 ($2,000 if you’re married filing jointly) off your taxes.

Roth IRAs can be especially valuable to younger investors like Millennials—people born in the 1981–1996 years—who have years of saving to go before retirement.

Financial Challenges for Millennials

Millennials are known for being tech-savvy. But they’re also known as a generation that faces a perfect storm when it comes to financial burdens. Here are some of them:

• Crushing student debt: College tuition has more than doubled since the 1990s, and student loan debt is at an all-time high.
• Rising home prices: Higher home prices—and larger down payments—mean that most Millennials are waiting longer to buy homes (if they buy at all).
• Soaring rents: Because they can’t afford to buy a home, Millennials are spending their money on soaring rents instead of building equity.
• Underemployment: Because of changing employment trends, there’s a general mismatch of skills in the workplace. Many Millennials rely on side gigs to get by.
• Caring for aging parents: More Millennials are caring for their aging parents, and they’re spending more of their own money to do so.
• Inflation: $1 million used to be a nice target for a retirement nest egg. But thanks to inflation, that amount in 40 years (at a rate of 3%) is projected to have the same spending power as about $306,557.

Why Roth IRAs Make Sense for Millennials

These financial challenges can make it tricky for Millennials to save for retirement. But even small contributions can grow to a sizable nest egg by the time retirement rolls around because of time (a millennial’s superpower) and the power of compounding.

What’s more, many Millennials will earn more money—and get bumped into a higher tax bracket—as they age. Here’s why that matters:

Once you put money into a Roth, you’re done paying taxes on it, as long as you follow the withdrawal rules. This means that many younger people will pay their taxes at a lower rate (early on) and enjoy tax-free withdrawals during retirement—when they’re more likely to be in a higher tax bracket.

How Roth IRAs Work

You can go online and open up a Roth IRA in a matter of minutes. Most Roth IRA providers have a streamlined process for doing so. And if you need help, you can speak (or live chat) with an account representative.

Roth IRA Contribution Limits

For 2023, you can contribute as much as $6,500 to a Roth IRA each year. For 2024, the amount is $7,000. There is an additional $1,000 catch-up contribution, available only to those who are age 50 or older for both 2023 and 2024. You don’t have to deposit the contribution all at once. You have 15 months—from January 1 to the tax year’s filing deadline in mid-April of the next year—to max out your contributions.

For the tax year 2023, the deadline to make a Roth IRA contribution is April 15, 2024.

Roth IRA Income Limits

The Internal Revenue Service (IRS) has rules regarding income for those who want to contribute to a Roth IRA. You must have earned income to contribute to a Roth, and you can’t contribute more than you earned from wages and other income. Thus, if you earned $4,000, that’s the most that you can contribute.

The IRS also has established an annual income limit, meaning that you may not be able to contribute to a Roth or your contributions could be reduced or phased out entirely. The phased-out income limitations also depend on your tax filing status, such as single or married filing a joint tax return.

2023

Single tax filers can’t contribute to a Roth in 2023 if they earn $153,000 or more. Your contribution is reduced if you make $138,000 to $153,000.

If you’re married filing jointly, you must make less than $228,000 to be able to contribute, and your contribution is reduced if you earn $218,000 to $228,000 in 2023.

2024

Single tax filers can’t contribute to a Roth in 2024 if they earn $161,000 or more. Your contribution is reduced if you make $146,000 to $161,000.

If you’re married filing jointly, you must make less than $240,000 to be able to contribute, and your contribution is reduced if you earn $230,000 to $240,000 in 2024.

Roth IRA Withdrawal Rules

The withdrawal rules for Roth IRAs are more flexible than those for traditional IRAs and employer-sponsored plans like 401(k)s. You can withdraw your Roth IRA contributions at any time, for any reason, without owing tax. And withdrawals of earnings during retirement (or at least once you hit age 59½) are tax-free as well.

Of course, if you’re a millennial today, that doesn’t help you now. But there are exceptions to the withdrawal rules that can help Millennials who are struggling with financial issues.

One nice one is called the first-time homebuyer exception. You can use as much as $10,000 of your Roth to buy, build, or rebuild a home, provided that you’re a first-time homebuyer. Meeting that restriction is easier than it sounds: The IRS considers you a first-time homebuyer if it has been at least two years since you owned a home. That $10,000 could be used toward a down payment on a property, or to cover unexpectedly high closing costs.

You can also make withdrawals free of penalties if the money is going to pay qualified higher-education expenses or to cover up to $5,000 of the costs of having or adopting a child.

Investing in Your Roth

The greatest advantage an investor has is time. Millennial investors have time to take advantage of the power of compounding, and years to ride out any stock market fluctuations.

History has shown that investments appreciate over time—despite inevitable downturns. As a result, Millennials are in a good position to take a little more risk in exchange for the higher potential rewards with investments such as:

• Individual stocks: Growth stocks and stocks that pay dividends are especially popular.
• Mutual funds: There are index funds and actively managed funds. Growth stock mutual funds can be ideal for many investors.
• Target-date funds: Decide what year you want to retire and pick a fund that matches. If you want to retire in 2040, for example, choose the (hypothetical) XYZ 2040 target-date fund. These funds automatically rebalance from higher-risk to lower-risk investments as you get closer to retirement.
• Exchange-traded funds (ETFs): ETFs are like mutual funds in that they usually track an index, but they typically cost less on an annual basis.
• Real estate: You can hold real estate investments in a Roth IRA, but you’ll need a self-directed Roth IRA to do so.

The Bottom Line

If you have earned income and meet the income limits, a Roth IRA can be an excellent tool for retirement savings. Once you put money into a Roth, you’re done paying taxes on it, as long as you follow the withdrawal rules. This means that many younger people will pay their taxes at a lower rate (early on) and enjoy tax-free withdrawals during retirement—when they’re more likely to be in a higher tax bracket.

But keep in mind that a Roth IRA is just one part of an overall retirement strategy. If possible, it’s a good idea to contribute to other retirement accounts as well. That way, you can boost your nest egg to help ensure that you’re ready for retirement, even if that’s decades away.