This Is Why Millennials Are Favoring the Roth IRA

This Is Why Millennials Are Favoring the Roth IRA

People have several different choices for retirement savings accounts, from HSAs to 401(k)s. An increasing number of people are realizing impressive savings with their 401(k)s—in fact, 233,000 Americans had more than $1 million in their employer-sponsored account at the end of 2019. A year prior, only 133,800 people had achieved this goal.

In the same time period, the number of people with more than $1 million in their IRA increased to a record high of 208,000. Similarly, the number of people with $1 million in their Thrift Savings Plan, a federal version of a 401(k), surged to 49,620 at the end of 2019. In all, it seems that Americans are becoming more focused on saving adequately for retirement.

The overall average savings in 401(k)s, 403(b)s, and IRAs increased a great deal from 2018 to 2019, up to $112,300, $93,100, and $115,400, respectively. All were up between 17 percent to 18 percent from the prior year.

But one of the most remarkable figures related to retirement savings has to do with millennials. This generation has received a lot of flak from older generations for their seemingly reckless spending. Despite this reputation, millennials collectively placed $373 million in IRAs in the fourth quarter of 2019 alone. This was a 46 percent increase over the total amount contributed in 2018’s fourth quarter.

Now, the average IRA balance for millennials is $32,700, up from $24,200 a year ago and $7,300 in 2009. While these increases reflect increased income, they also demonstrate this generation’s newfound focus on retirement savings.

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Millennials Invest Heavily in Roth IRAs and Other Roth Accounts

Interestingly, the retirement savings vehicle of choice for millennials is the Roth IRA, according to statistics released by Fidelity. A Roth account is funded with post-taxed money, which means that individuals make withdrawals from the account down the road without paying any taxes on the cash. Because Roth IRAs have income limits, younger workers are more likely to be eligible to contribute to them.

Also, millennials have increasing access to hybrid Roth 401(k)s through their employers. This type of account is still funded with after-tax dollars, but individuals can contribute more than $6,000, which is the annual limit on traditional Roth IRAs. The Roth 401(k)’s contribution limit is $19,500, the same as a traditional 401(k).

A Roth account makes a lot of sense for the millennial saver. After all, millennials are likely to be in a lower tax bracket now than down the road when they retire. The money in the account then grows without tax for years, and the power of compounding will likely far outweigh the benefit of tax deductions in the current year for contributions to a 401(k).

Furthermore, Roth accounts may be beneficial once millennials reach retirement since they do not come with required minimum distributions. For that reason, these accounts are great for wealth transfers. Also, individuals can contribute to Roth accounts at any age provided that they meet eligibility requirements and continue to have earned income. People may be able to get around some of the eligibility requirements with a backdoor Roth IRA.

What Millennials Need to Know about Investing in Roth Accounts

A Roth IRA has a unique set of withdrawal rules that are more flexible than traditional IRAs and 401(k)s. Individuals can withdraw from this account at any time and for any reason without needing to pay tax. Once they hit retirement age, account holders can withdraw earnings on their investment without paying taxes.

Millennials should be aware of several interesting rules, such as the first-time homebuyer exception. With this exception, individuals can use up to $10,000 of a Roth IRA to build, rebuild, or buy a home provided that they are a first-time homeowner. According to the IRS, individuals are first-timers if it’s been at least two years since they owned a home. Millennials can also make penalty-free withdrawals for covering higher-education expenses and up to $5,000 to help with the cost of having or adopting a child.

Millennials can take advantage of compounding interest when they invest significantly in a Roth IRA today. Notably, millennials have a long time before they will need the money, so they can be riskier with investments and ride out fluctuations in the market.

They can also invest in a number of different types of securities through a Roth IRA, such as individual stocks and mutual funds. Growth stocks, which pay regular dividends, have become especially popular among millennials. They may also want to check out target-date funds, which automatically rebalance in set intervals to readjust risk as they get closer to their expected retirement date.

Also, individuals can hold real estate investments in a Roth IRA provided that it is a self-directed account. Exchange-traded funds, which are like mutual funds with lower annual fees, are also a good option.