Younger people tend to be in a lower tax bracket now than they'll be in retirement—which is one reason why Roth IRAs are ideal for millennials.

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

Key Takeaways

  • Roth IRAs are ideal retirement savings accounts if you're in a lower tax bracket now than you expect to be in during retirement.
  • Millennials are well-poised to take full advantage of a Roth IRA’s tax benefits and decades of tax-free growth.
  • You'll pay taxes now on contributions, but withdrawals are tax-free in retirement.

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

Advantages 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:

Roth IRAs can be especially valuable to younger investors like Millennials—people born between 1981 and 1996—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 1980s, and student loan debt is at an all-time high.
  • Rising home prices. Higher home prices—and larger down payments—means 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 will have the same spending power as about $270,000.

10 years

The amount of time it can take to save for a 20% down payment on a house, according to a report from SmartAsset.

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.

41%

The number of new Roth IRA accounts in 2018 that were opened by Millennials.

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.

You could owe taxes and a 10% penalty on non-qualified distributions.

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.

For 2019, you can contribute up to $6,000 ($7,000 if you're age 50 or older) to a Roth IRA. But you don't have to deposit it all at once. You have 15 months—from Jan. 1 to the tax year’s filing deadline in mid-April of the next year—to max out your contributions.

However, there are two income requirements for Roth IRAs:

  • You must have "earned income" to contribute to a Roth IRA. You can't contribute more than you earned from wages and other income. So, if you earned $4,000, that's the most you can contribute.
  • High earners may not be able to make the full contribution (or any at all). For 2019, your contribution is reduced if you make between $122,000 and $137,000 as a single filer, or $193,000 and $203,000 if you're married filing jointly. If you make above the upper limit for your category, you can't contribute at all to a Roth. 

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 during retirement are tax-free, as well.

Of course, if you’re a Millennial today, that doesn’t help you now. But there is something that can help Millennials who struggle to save for a down payment. It's called the first-time homebuyer exception.

You can use up to $10,000 of your Roth to buy, build, or rebuild a home, provided you’re a first-time homebuyer. Meeting that restriction is easier than it sounds. The IRS considers you a first-time homebuyer if it's been at least two years since you owned a home.

Investing in Your Roth

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

A Roth IRA is an account that you put investments into. It's not an investment on its own.

History has shown that investments appreciate over time—despite the 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 like:

  • 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 XYZ 2040 target-date fund. These funds automatically rebalance from higher-risk to lower-risk investments as you get closer to retirement.
  • Exchange-Traded Fund (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. But keep in mind that it’s 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 you're ready for retirement, even if that's decades away.