Young adult retirement savings: Traditional vs. Roth IRAs


As more than half of 16-to-24-year-olds are gainfully employed, according to the Bureau of Labor Statistics, it’s crucial to guide the younger generation toward financial responsibility and long-term planning. While a job provides valuable lessons, why not take it a step further and encourage them to start saving for retirement? Young adults with earned income can make annual contributions to tax-favored traditional IRAs or Roth IRAs, setting the stage for a financially secure future.

Contribution Limits: Both traditional and Roth IRAs share the same contribution limits. For the 2023 Young adults with earned income can make annual contributions to tax-favored traditional IRAs or Roth IRAs, setting the stage for a financially secure future.tax year, individuals can contribute up to the lesser of $6,500 or their earned income from wages or self-employment. (As of the 2024 tax year, individuals can contribute up to the lesser of $7,000.) The deadline for contributions is April 15, 2024, emphasizing the importance of starting early to benefit from compounding and tax-sheltered earnings.

Tax Advantage of Traditional IRAs: Traditional IRAs offer potential deductibility, dependent on factors such as tax filing status, income, and participation in tax-favored retirement plans. Understanding the phase-out rules based on adjusted gross income (AGI) is crucial for maximizing this advantage.

Downsides of Traditional IRAs: While traditional IRAs have their advantages, withdrawals are taxable, and early withdrawals before age 59½ incur a 10% penalty tax. Additionally, traditional IRAs are subject to required minimum distribution (RMD) rules, compelling withdrawals after reaching a certain age.

Tax Advantages of Roth IRAs: Roth IRAs provide tax-free qualified distributions, making them appealing for the long term. Contributions are not tax-deductible, but this is balanced by the flexibility of penalty-free withdrawals of the contributed amount. Furthermore, Roth accounts are exempt from RMD rules during the account owner’s lifetime.

Downsides of Roth IRAs: One drawback of Roth IRAs is the non-deductibility of contributions, and there are income restrictions for making annual contributions. Understanding the AGI phase-out ranges is essential to navigate these limitations.

Lessons Learned: Choosing between traditional and Roth IRAs depends on individual circumstances. Traditional IRAs may suit those needing tax savings from deductible contributions, while Roth IRAs are ideal for those anticipating higher tax brackets during retirement. Income restrictions can be navigated through nondeductible traditional IRA contributions or converting traditional IRAs into Roth IRAs, with tax implications to consider.

Guiding young adults in understanding the nuances of traditional and Roth IRAs is vital for optimal retirement savings and estate planning. Consulting with a tax advisor will help chart the most effective strategy for their financial future.