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4 Things Millennials Should Know About Roth IRAs

millennial man learns about the benefits of roth iras

Time Is on Your Side

One great way to save for retirement is by consistently contributing to an individual retirement account (IRA) throughout your working years. This strategy can be especially impactful for millennials, who have time on their side and can truly benefit from the power of compounded earnings that can grow for decades before they need to access the money.

There are two main types of IRAs:

  • Traditional IRAs
  • Roth IRAs

While both traditional and Roth IRAs offer unique advantages and tax benefits, if you’re a millennial, it may be most beneficial to focus on saving in a Roth IRA. Roth IRAs offer the benefits of tax-exempt earnings over decades and tax-exempt withdrawals in retirement (if over age 59 ½ with an account that has been open for more than five years).

Following are four things millennials should know about investing in a Roth IRA.

#1 – Roth contributions are made with after-tax funds.

When you contribute to a traditional IRA, you do so with pre-tax funds, which reduces your taxable income during the year in which contributions are made. These assets can grow tax-deferred for retirement. However, “tax-deferred” is the IRS’ way of saying you’ll eventually be required to pay taxes on that money when withdrawn during retirement.

In contrast, Roth IRA contributions are made with after-tax funds. You don’t receive a tax benefit in the year you make contributions, but you also don’t pay taxes on your contributions when you withdraw them in retirement (again, so long as you’re over age 59 ½ with an account that has been open for more than five years). This can be a huge benefit, especially if you expect to be in a higher tax bracket when you retire and withdraw the money.

#2 – Higher-income earners are phased out from contributing to Roth IRAs.

In 2024, the maximum you can contribute to a Roth IRA is $7,000 per year (individuals over age 50 can make an extra $1,000 catch-up contribution). However, that amount is gradually reduced for individuals with a modified adjusted gross income (MAGI) between $146,000 and $161,000 ($230,000 to $240,000 for married couples filing jointly). Once you reach the maximum income threshold, you’ll be ineligible to contribute to a Roth IRA.

As a general rule, you have until the tax filing deadline to make IRA contributions for the prior year. To contribute to an IRA, you must have compensation (e.g., wages, salary, tips, bonuses, etc.). In some cases, a non-working spouse may be able to make an IRA contribution if filing jointly with their spouse.

One of the main reasons we recommend millennials contribute to a Roth IRA is that their income is likely to grow over time as they progress in their career. Once their income reaches a certain threshold, their opportunity to participate will close.

#3 – Roth IRAs aren’t subject to required minimum distributions (RMDs).

With a traditional IRA, you’re required to withdraw a certain amount each year once you reach a certain age. These funds are taxed at ordinary income tax rates unless the funds are made payable to a qualified charity.

Roth IRA contributions are made with after-tax funds and aren’t subject to RMD rules. This provides you with the flexibility to decide when to withdraw your assets and allows your money to continue growing within the account for as long as you want.

#4 – Roth IRA assets can be used before retirement.

In an ideal situation, you would contribute to a Roth IRA and not touch those assets until retirement. However, life happens and sometimes you need access to emergency funds.

In contrast to traditional IRA contributions, Roth assets aren’t subject to an early withdrawal penalty if you withdraw funds before you reach age 59 ½. That means you have some flexibility to use your Roth account as a source of emergency savings. Just be sure to limit any withdrawals to contributions, as earnings will be subject to ordinary income tax and may be assessed a 10% early withdrawal penalty if you access them before you reach age 59 ½.

You may also be able to avoid penalties (but not taxes) in certain circumstances, such as a withdrawal to pay for qualified education expenses or put toward your first home (up to a $10,000 lifetime maximum).

Are you interested in learning more about your retirement savings options? Creative Planning is here for you. Our experienced teams take time to get to know you, your current financial situation, your goals for the future and any challenges you may face before offering well-informed, custom solutions to meet your needs. For more information, schedule a call with a member of our team.

This commentary is provided for general information purposes only, should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.

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