Roth IRAs are ‘a knockout blow’ for most young investors, expert says

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The youngest workers entering the workforce, Generation Z, whose ages range from 10 to 25, showed dramatic adoption of individual retirement accounts, according to second-quarter data. Posted by Fidelity Investments this week.

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

IRA adoption was particularly strong among young investors, with a year-over-year increase of 92% among Gen Z and 24% among millennials.

That’s how the total number of IRA accounts at Fidelity rose 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 young investors.

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

This is why.

‘It takes two minutes’ to open an IRA

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

A key reason is the democratization of access to investment resources, he said.

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

“Access to financial matters and savings has become much easier for younger generations than for previous generations,” he said.

It’s not just full-time young professionals 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 her earnings from her after-school job at a coffee shop.

Sun’s advice to young investors just starting out: Really educate yourself on the pros and cons of these accounts before you dive in.

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

Why Roth IRAs attract the enthusiasm of young investors

There are two types of IRAs to choose from: traditional and Roth IRAs.

With traditional IRAs, you invest money before taxes and typically take 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 withdrawals in retirement. When it comes time to live on that money in retirement, whether or not you have a tax bill, it’s likely to make a big difference in your lifestyle.

“We’re definitely seeing more enthusiasm for Roth than traditional,” Assaf said.

Fidelity data found that the number of contributing millennial Roth IRAs increased 7.8% year-to-date.

A key reason for the interest is the tax benefits that Roth IRAs provide.

It’s important to note that you can withdraw your contributions at any time and for any reason without penalty or tax.

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

In particular, there are income limits to be eligible to contribute to Roth IRAs, so it’s important to think about whether you’ll earn more now or in the future. Your total income during retirement, as well as whether you’re drawing from traditional or Roth accounts, will also determine how large your tax bills will be in those later years.

Because many young workers are in their lowest-earning years, getting a tax deduction for traditional pre-tax retirement 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 opportunity to build from a dollar as a young person, all tax-free,” Slott said.

‘Pretend this money is locked away’

Were you offered a 401(k) match? make it a priority

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

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

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

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

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

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

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