When I first learned about a Roth IRA, I was surprised by how simple it was to save for retirement even as a young adult. Unlike a traditional IRA, where you pay income taxes later, a Roth lets younger investors pay them now while they’re in lower tax brackets. That means your money can grow tax-free for years.
Many Gen Z and Generation Z members don’t realize that opening an individual retirement account early can help them achieve big investment goals later. As a financial planner, I’ve seen how an early start can make a huge difference in your career and future wealth.
Why Gen Z Should Start Early
A recent Bank of America survey found that only one in five Gen Zers are contributing to a retirement account. Some feel financially vulnerable or unsure how to invest, but experts like Kamila Elliott, co-founder and CEO of Collective Wealth Partners, told CNBC Make It that it’s necessary to participate in the market to reach long-term asset goals.
Winnie Sun from Sun Group Wealth Partners also recommends that young people start early, even with small income. Yes, you’ll have expenses, but finding the best plan and taking action to save, invest, and open your account now will help you build financial freedom. Investing may sound hard at your career beginning, but it’s all about market participation, discipline, and believing in your future.
Key Takeaways
- Roth IRA contributions offer stronger long-term advantages for young people compared to traditional contributions in a traditional IRA.
- Tax-free distributions during retirement become more valuable if taxes increase in the future.
- Younger investors benefit more from compounding growth due to a longer time horizon, boosting savings potential.
- Most young people fall into lower tax brackets, making deferring taxes through a traditional IRA less effective early on.
- As income and future earnings rise, individuals may surpass income limits and become disqualified from contributing to a Roth IRA.
Maintaining a balance by contributing to both Roth contributions and traditional contributions throughout a lifetime maximizes benefit and flexibility.
Roth vs. Traditional IRAs
Both Roth IRA and Traditional IRA accounts help you grow your money for the future, but they work in different ways. With a traditional account, you get a tax deduction for your contributions, and your gains can enjoy tax deferral until you withdraw funds.
However, when you start making withdrawals, they are taxed based on your tax bracket at that time. This means your total return depends on how high your future taxes will be.
In contrast, Roth IRA contributions are not tax deductible, but your withdrawals can be tax-free if you follow the rules. Younger investors who are starting out in their careers are usually in lower tax brackets, so they may not get much benefit from tax deductions now.
Instead, experts say the wiser choice for 20-somethings is a Roth, since their account has more time to compound, allowing stronger account growth. As younger investors begin saving early, they can afford to skip an immediate tax deduction and focus on long-term tax-free growth that could help them someday when they retire.
Traditional IRA Tax Benefits
Traditional IRAs have long offered strong tax benefits to help Americans save for retirement. It dates back to the 1970s, when it was the only choice for most people. The government provided this attractive incentive to encourage saving but still wanted its cut later. That’s why account holders face a tax bill when they withdraw money.
These withdrawals are mandatory after a certain age—currently 73 if you were born between 1951 and 1959, or 75 if born in 1960 or later. These are called required minimum distributions (RMDs), and they ensure the tax obligation isn’t avoided forever.
A simplified example shows how a traditional IRA can grow in value while also increasing your tax obligation. Suppose you’re 23 years old, earn $50,000 in taxable income, and contribute the maximum allowed of $7,000 in 2024 and 2025.
Being in the 22% tax bracket gives you a tax deduction of about $1,540 in federal income tax, which can save you approximately that amount each year. However, experts note that while you accumulate savings faster upfront, the result is higher taxes later when you start taking withdrawals in retirement.
Important
A Roth IRA lets you withdraw your contributions without paying taxes or early-withdrawal penalties before age 59½, which is different from a traditional IRA. With a traditional IRA, if you contribute $7,000 each year from when you’re starting out until 63 years old (a total of 40 years, equal to $280,000), your account could grow to $1.8 million assuming an 8% annual return.
If all contributions were fully deductible, you could have saved $61,600 in taxes, staying in a 22% tax bracket throughout those years. When you retire and withdraw $50,000 annually for living expenses, federal income tax at $11,000 per year would leave you with only $39,000. If you’re in a higher tax bracket later due to increased income or rising tax rates, you could owe more.
By age 75, it becomes a mandatory choice to start taking withdrawals and continue paying taxes. Experts highlight that while the simplicity of a Roth IRA offers possible long-term benefits, careful planning is essential to remain on track and understand what you may owe in the future.
Roth IRA Tax Benefits
A Roth IRA, introduced in 1997, works differently from a traditional IRA. If you contribute $6,500 per year for 40 years, your account can grow to $1.8 million with an 8% annual return. At age 63, you can withdraw $50,000 per year, and because distributions are tax-free, you keep the full amount. This is possible once the account has been open for at least five years and you reach age 59½. The Roth withdrawal allows you to start taking money without worrying about taxes, unlike a traditional IRA.
Another key difference is that RMDs do not apply to a Roth IRA during the original owner’s lifetime. If you don’t need the money, you can pass along the account to your heirs when you die, and their withdrawals can also remain tax-free. In this scenario, you can take as much as you want and keep the full amount, making the Roth a flexible option for young adults who want long-term growth and tax advantages.
FREQUENTLY ASKED QUESTIONS:
How Much Can You Contribute to a Roth Individual Retirement Account (IRA)?
For tax year 2024, the maximum amount you can contribute to a Roth IRA or a traditional IRA is $7,000 if you are under age 50, or $8,000 if you are age 50 or older. These limits stay the same for tax year 2025. You can combine contributions across individual retirement accounts to meet these contribution limits, giving young adults a clear path to start saving early for retirement.
Who Is Eligible to Contribute to a Roth IRA?
To contribute to a Roth IRA, you must have earned income from a job or self-employment at least equal to the amount you plan to contribute. Eligibility also depends on income limits. For a single taxpayer in tax year 2024, a full contribution is allowed if your modified adjusted gross income (MAGI) is under $146,000.
Partial contributions are possible up to $161,000, and above that, you are ineligible. In 2025, the income phase-out range rises to between $150,000 and $165,000, ensuring young investors know their contribution requirements.
Are Roth 401(k) Plans a Good Idea for Young Investors?
A Roth 401(k) offered by your employer works much like a Roth IRA but with higher contribution limits, allowing you to save more for tax-free income in retirement. Thanks to the SECURE 2.0 Act, RMDs are exempted as of 2024, so your account can continue to grow tax-free during your lifetime.
The original account owner enjoys this benefit, though beneficiaries will eventually take withdrawals, which can also remain tax-free, making it a strong option for young investors planning long-term growth.
The Bottom Line
For young adults focused on financial planning and savings, a Roth IRA can be a wiser long-term choice compared to a traditional IRA, even though contributions to traditional IRAs are tax-deductible. This account provides an effective investment strategy and solid benefit for retirement planning, helping early investors set a strong foundation for the future.
Disclaimer: This content is for informational purposes only and does not constitute financial, tax, or investment advice. Always consult a certified financial planner, tax professional, or other qualified advisor before making decisions about Roth IRAs, traditional IRAs, or any other investment or retirement planning strategies.
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