Gen Z Guide to Roth IRAs

Is it ever too early to start investing? Experts say no—and Gen Z is listening. For those born in the 1997–2012 years, the time to act is now. As this generation starts their careers, they are diving into the investing pool, with a record 1.4 million Gen Z workers contributing to retirement accounts through Fidelity’s platform alone.

Zoomers are not only choosing to invest early but also choosing tax-advantaged investment tools, especially Roth individual retirement accounts (Roth IRAs). Up to 95% of IRA contributions in the third quarter (Q3) of 2021 went to Roth IRAs.

So what is a Roth IRA, and why do zoomers love them?

Key Takeaways

  • Investors use after-tax dollars to contribute to a Roth individual retirement account (Roth IRA).
  • Their contributions can be withdrawn with no penalty for qualified reasons.
  • Anyone can start a Roth IRA, regardless of age, as long as they earn income.
  • Withdrawals after age 59½ are tax- and penalty-free.
  • There is no mandatory disbursement age for funds.

How a Roth IRA Works

A Roth IRA is an individual retirement account that accepts contributions using after-tax dollars. Because they are taxed up front, there is no tax burden when money is withdrawn later in life. A traditional IRA does the opposite—contributions are made with pretax dollars, which lowers your yearly income for tax purposes. While a Roth IRA doesn’t help you in the year when you invest, it could save a lot of money in tax payments later.

Who Can Have a Roth IRA?

Anyone of any age can have a Roth IRA, as long as they meet certain conditions:

For example, if 14-year-old Sienna earns money from a part-time restaurant job, she is eligible to contribute to a Roth IRA. If she earned $5,000 that year, she can contribute up to $5,000. She can’t contribute money that was given to her as either gifts or an allowance.

Just as there are limits on what type of money you can contribute, there are limits to how much you can contribute, based on your MAGI. For 2022, an individual may contribute up to $6,000 ($7,000 if age 50 or older) in a Roth IRA, as long as their MAGI falls below $129,000 for 2022. For married couples, the combined limit for full contribution is $204,000 or less for 2022.

For higher earners, the contribution amounts are reduced on a graduated scale until a certain threshold ($144,000 for single filers in 2022), at which point they can’t contribute to a Roth IRA at all. They can, however, contribute to taxed investment accounts such as brokerage accounts.

You can only contribute earned income—wages, salaries, bonuses, or self-employment income—to a Roth IRA.

Benefits of Roth IRAs

Roth IRAs offer the opportunity to pay your taxes up front, eliminating taxes on withdrawals when you retire. For those who believe they are in a lower tax bracket now than they will be when they retire, this can be a huge advantage. Since most of Gen Z is just starting out in their careers, it’s easy to assume that their earnings and tax bracket will only go up from here.

The ability to withdraw your contributions at any time is also a huge asset. You can withdraw the money that you’ve contributed to your Roth IRA at any time—you’ve already paid taxes on it, so there are no fees, penalties, or taxes. With a limit of $6,000 ($7,000 if age 50 or older) per year, the money that you contribute is essentially in a hard-to-access holding account as its earnings are reinvested.

Roth IRAs are friendlier to entrepreneurs. If you can prove that you earned income, then you can open a Roth IRA, regardless of age. Many other investment tools have age requirements that eliminate young people altogether.

You also don’t have to withdraw the money at any certain time—or ever. Unlike traditional IRAs that require you to take minimum distributions at age 72, Roth IRAs allow you to keep the money indefinitely. You can even pass it on to your heirs untouched, and they can inherit the money tax free as well.

Drawbacks of Roth IRAs

Ideally, your investment will earn money as well. Withdrawing your earnings has a different set of standards. To withdraw your earnings without penalty before age 59½, you must certain conditions, such as the following:

  • You are using the funds to buy or build your first home.
  • You have a permanent disability.
  • You are the recipient of the Roth IRA from the original owner’s death.

Earnings may be withdrawn for other reasons, but they will be taxed at your current income rate, as well as incurring a 10% penalty. Earnings may be withdrawn penalty free to pay for education expenses for you, a spouse, or a child, but the withdrawal will still be taxed.

Although tax-free income in your retirement years is ideal, lowering your tax burden now is also attractive. The money that you save in taxes now can be invested for the future.

What counts as earned income for a Roth individual retirement account (Roth IRA)?

Earned income for a Roth individual retirement account (Roth IRA) is typically considered wages, salaries, tips, bonuses, commissions, or self-employment income. There are some out-of-the-ordinary forms of income as well, such as income from selling non-qualified stock options, or certain scholarships or fellowships. If you are married but don’t earn taxable income, you may open a spousal Roth IRA using your spouse’s income.

Can I have both a Roth IRA and a traditional IRA?

Yes, you can contribute to both a Roth IRA and a traditional IRA. However, you can only contribute up to the yearly Internal Revenue Service (IRS) limit for both accounts. For example, you can contribute $3,500 to your Roth IRA and $2,500 to your traditional IRA in 2022. You cannot contribute $6,000 ($7,000 if age 50 or older) to both accounts in the same year.

Will Gen Z pay higher taxes in retirement?

Tax law is highly variable and changes frequently. There’s no guarantee of what the tax code will look like by the time Gen Z reaches retirement age.

The Bottom Line

As they enter the workforce, Gen Z has a huge opportunity to leverage their lower tax bracket to harvest wealth in their retirement years. Roth IRAs may not lower your taxes now, but tax-free income at retirement can make a huge difference, depending on how the tax code changes. Roth IRAs also offer flexible investing options for those who are thinking of buying a home or sending a loved one to college in the future.

Article Sources

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  2. Internal Revenue Service. “Traditional and Roth IRAs.”

  3. Internal Revenue Service. “Publication 590-A (2021), Contributions to Individual Retirement Arrangements (IRAs): Is There an Age Limit for Contributions?

  4. Internal Revenue Service. “Publication 590-B (2020), Distributions from Individual Retirement Arrangements (IRAs): What Are Qualified Distributions?

  5. Internal Revenue Service. “Publication 590-B (2020), Distributions from Individual Retirement Arrangements (IRAs): Must You Withdraw or Use Assets?

  6. Internal Revenue Service. “Publication 590-A (2021), Contributions to Individual Retirement Arrangements (IRAs): Roth IRAs Only.”

  7. Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2022.”

  8. Internal Revenue Service. “Retirement Topics — IRA Contribution Limits.”

  9. Internal Revenue Service. “Publication 590-A (2021), Contributions to Individual Retirement Arrangements (IRAs): Compensation.”

  10. Internal Revenue Service. “Retirement Plan and IRA Required Minimum Distributions FAQs.”

  11. Internal Revenue Service. “Topic No. 557 Additional Tax on Early Distributions from Traditional and Roth IRAs.”

  12. Internal Revenue Service. “Publication 590-A (2021), Contributions to Individual Retirement Arrangements (IRAs): What Is Compensation?

  13. Internal Revenue Service. “Publication 590-A (2021), Contributions to Individual Retirement Arrangements (IRAs): Can You Contribute to a Roth IRA for Your Spouse?

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