Roth IRAs are ‘a slam dunk’ for most young investors, expert says

kate_sept2004 | E+ | Getty Images

The youngest workers entering the workforce — Gen Z, ages 10 to 25 — have shown dramatic adoption of Individual Retirement Accounts, second-quarter data shows published by Fidelity Investments this week.

Fidelity IRAs held by this generation grew 87% in the second quarter of 2021, according to the investment firm. Millennials, ages 26 to 41, saw a 24% increase in the number of IRA accounts at Fidelity over the same period.

IRA adoption has been particularly strong among young female investors, with a 92% year-over-year increase among Gen Z and 24% among Millennials.

That’s when the total number of IRAs at Fidelity soared 10.6% in the second quarter from a year earlier to 12.8 million.

Experts say opening an IRA is smart, but the type of IRA you choose is also important.

Ed Slott, CPA and founder of Ed Slott & Co. said he always recommends Roth retirement accounts to younger investors.

“For young people, it’s just a slam dunk,” Slott said.

Here’s why.

“It takes two minutes” to open an IRA

Growth in IRA adoption has been strong among younger investors for several years, according to Rita Assaf, vice president of retirement products at Fidelity.

One of the main reasons for this is the democratization of access to investment resources, she said.

“It takes two minutes to open the app and create an account no matter where you have it,” Assaf said.

“Access to financial topics and savings has become so much easier for younger generations than it was for previous generations,” she said.

It’s not just young full-time professionals who are opening these accounts.

Financial adviser Winnie Sun, managing director and founding partner of Sun Group Wealth Partners, said this week that she helped a 16-year-old set up her first Roth IRA to invest earnings from her after-school job. in a coffee shop.

Sun’s advice to young, first-time investors: really do your research on the pros and cons of these accounts before you get started.

“Don’t invest until you fully understand what you’re investing in,” Sun said.

Why Roth IRAs Are Exciting Young Investors

There are two types of IRAs you can choose from: traditional accounts and Roth IRA accounts.

With traditional IRAs, you invest the money before tax and typically get a deduction on those contributions, then pay taxes on the withdrawals in retirement.

With Roth IRAs, you invest money you’ve already paid taxes on, in exchange for tax-free retirement withdrawals. When it comes time to live with that money in retirement, whether or not you have a tax bill will likely make a big difference in your lifestyle.

“We’re certainly seeing more enthusiasm around Roth than in the traditional way,” Assaf said.

Fidelity data revealed that the number of Millennial Roth IRA accounts with contributions has increased 7.8% so far this year.

One of the main reasons for the interest is the tax benefits provided by Roth IRAs.

Above all, you can withdraw your contributions at any time for any reason without penalty or tax.

“You are covered in case of an emergency,” Assaf said.

Notably, there are income limits on being able to contribute to Roth IRAs, so it’s important to consider whether you’ll earn more now or in the future. Your total income in retirement – ​​as well as whether you draw from traditional or Roth accounts – will also determine the amount of your tax bills in later years.

Since many young workers are in their lowest earning years, getting a tax deduction for traditional pre-tax pension contributions is less valuable, Slott said. Plus, you’ll have to pay taxes on that money later, when rates are likely to be higher.

With a Roth, “you have the ability to build from a dollar as a youngster, all tax-free,” Slott said.

“Pretend that money is just locked away”

Investors can face penalties if they withdraw income from their investments if they don’t meet the five-year mark since they first contributed to a Roth IRA account, as well as other requirements.

Sun said she uses simple numbers to explain the concept to new investors.

If they invest $1,000 in a Roth IRA, they will be able to withdraw those contributions. But any money accumulated on this investment cannot be withdrawn without penalty. So if the balance reaches $1,200, they can pay extra to withdraw the extra $200.

“They learn the concept of liquidity and long-term investing in a very short conversation,” Sun said.

Learn more about the Investor Toolkit:
3 tips for paying off your credit card balance
House Democrats call for Social Security reform
Investors flock to green energy funds

Steve Kurashima, CPA and owner of Los Angeles tax and accounting firm Kurashima and Associates, said he encourages his business owner clients who employ their children to open IRA accounts for them.

“It allows parents to instill an investment and retirement mentality in children,” Kurashima said.

Ideally, young investors should view funds as long-term investments.

“I tell them you want to pretend that this money is just locked away until you’re 59½ and beyond,” Sun said.

Offer a 401(k) match? Make it a priority

Before investing in an IRA, take a look at your complete financial picture, experts advise.

“If you have access to a 401(k) with a corporate match, try to save up your corporate match” before investing in an IRA, Assaf said.

“If you don’t save up to that, you’re leaving free money on the table,” she said.

Fidelity generally recommends working professionals set aside 15% of their income, including a company match, for retirement.

Admittedly, that might seem like a lofty goal if you’re just starting out or feeling the pinch of rising prices, Assaf said. But if you can find some extra money to invest now, you’ll probably be glad you did later.

If you don’t have a sufficient emergency fund, you might want to prioritize that first, Assaf said, so you aren’t tempted to plunder your retirement funds if unforeseen needs arise.

Robert D. Coleman