The rise of the Roth IRA: Gen Z and millennials have a new favorite investment account

Despite a bleak financial picture that includes student loan debt and rising inflation, many young people have still managed to make remarkable strides when it comes to growing their wealth. The latest evidence: Significantly more Gen Zers and millennials are investing outside the workplace.

The percentage of households headed by a twenty-year-old investing in a Roth IRA nearly tripled from 2016 to 20226.6% to 19.2% according to data from the US Federal Reserve analyzed by the Boston College Center for Retirement Research (CRR) . No similar increases were seen in households headed by older age groups or in 401(k) participation.

The increase in Roth IRA use was concentrated among the third highest earners, according to the CRR analysis, which the organization credits to fintech platforms like Robinhood making access to financial instruments easier in recent years.

Also in play: Many young families, especially wealthy ones, were able to invest a lot of money during the pandemic, at least compared to what they had before. Earlier research from the Federal Reserve found that inflation-adjusted wealth for Americans under the age of 40 grew by a staggering 80% between the first quarter of 2019 and the third quarter of 2023, largely the result of investments in stocks.

During the pandemic, people had more time on their hands, stimulus checks and took advantage of a market downturn, says Evan Potash, executive advisor of wealth management at TIAA. This is compounded by the fact that young career starters, who tend to earn less than those further along in their career cycle, have not yet moved away from Roth IRA contributions.

While this is good news for top earners, those at the other end of the income spectrum are not doing so well. CRR’s research found that just 4% of households headed by twenty-somethings in the bottom third of the income distribution are investing in a Roth in 2022. That’s still up from 2% in 2016, but it’s significantly more slightly less than 41% of those in the top third.

Ultimately it seems that if technology makes it really easy to save in tax-advantaged accounts, the tech-savvy with money will take advantage of the opportunity, wrote Alicia Munnell, director of CRR.

Other studies have also found that the wealth gap between the poorest and richest young people is widening. According to a study published by the University of Chicago Press, the richest 10% of millennials have 20% more wealth than the richest boomers. Meanwhile, those at the other end of the income spectrum have seen their wealth stagnate, at best, or decline at worst.

401(k)s vs. Roths

Although 401(k)s get a lot of love from the financial press and advisors, Americans keep far more of their total retirement assets in individual accounts. More new investors getting into the game earlier can help them grow their wealth significantly over time due to compounding returns.

And a Roth IRA is one of the best ways for young people in particular to start investing, experts say. Because of the way its structured investors contribute money that is already taxed, and then the investments grow tax-free until retirement; it’s a good deal for those in lower tax brackets who don’t need the tax relief offered by a traditional IRA or 401(k) right now. In general, employees earn less when they are young than when they are older.

Additionally, Roth IRAs are an especially good deal right now given how low federal income taxes are, although that could change in the coming years.

The sooner you start saving in a Roth IRA, the more time you have for growth, adds TIAA’s Potash.

Although the growth in IRA investments is concentrated among the highest earners, it is another indication that young people are serious about investing and are doing so earlier than previous generations. Previous research has found that the average Zer general started putting money away for retirement at age 2,215 years earlier than the average baby boomer.

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