5 Reasons to Start a Roth IRA While You’re Young

Disclosure: Our content does not constitute financial advice. Speak to your financial advisor. We may earn money from companies reviewed.  Learn more

Last Updated on: 27th August 2021, 06:32 pm

Although sometimes overlooked, the Roth IRA is perhaps the best tool available for young investors and millennials looking to build a financially secure life. According to a 2019 survey, only about 25% of millennials between the ages of 23 and 38 have a Roth IRA. This points to the fact that many young Americans simply aren't taking advantage of the financial tools available to them. 

There are myriad reasons to start a Roth IRA while young, from having the ability to retire earlier to saving potentially hundreds of thousands of dollars on taxation. During one's youth, it's always a good idea to invest in oneself, and a Roth IRA is the best way to do it while allowing your investments to grow and compound tax-free. In this article, I'll list the best reasons to start a Roth IRA while you're young. 

1. Long-Term Compounding Power

When you're young, you have the luxury of long-term financial compounding at your disposal. A young investor’s Roth IRA allows their contributions to reliably compound at an average annualized return (AAR) of about 7% (inflation-adjusted) for 30 or 40 years. 

We're often asked, “How much can a Roth IRA grow in 30 years?” The answer, well, is a lot. Even modest investments can accrue hundreds of thousands of dollars in compound returns in a low-risk index fund or a fund tracking a market benchmark such as the S&P 500. 

Let's take the example of a young investor who contributes $200 per month to an index fund in a Roth IRA beginning on their 18th birthday. In this case, after 48 years (bringing the investor to about the official retirement age in the United States) of compounding at 7% interest annually, the investor would have $909,597 (tax-free) on the day they retire. This, despite only contributing $200 monthly over the course of their working career. 

If this investor had waited until they were 40 years of age to start funding their Roth IRA, they would retire with only $178,761—a far cry from what the average retiree needs to survive on. Even if they doubled their investment (i.e., $400 monthly) they would only retire with $357,522, less than half what they would’ve had if they started at age 18 with half the monthly investment.

2. It Can Give Your Kids a Head Start

A Roth IRA for kids can provide a massive boost to their retirement savings and can help ensure multi-generational financial security. This, of course, also pays dividends for parents, since a financially secure adult child is in a much stronger position to care for their parents in their old age. 

As parents, one of our foremost responsibilities is to provide a strong financial footing for our kids so that they can be better off than ourselves. Fortunately, there are no Roth IRA age minimums. A parent or guardian can open a Roth IRA (or Traditional IRA) for a minor at any age, which can then be habitually contributed to on a weekly, monthly, or annual basis. 

Plus, if your child runs into financial issues later in life, they'll have a safe nest egg to draw from if the situation calls for it. Although they would incur a 10% early withdrawal penalty, the funds vested in their Roth IRA could bail them out of a crisis or potentially provide a down payment on a first house.

3. Tax-Free Growth

Most of us earn progressively more money as we age. While this is great, the corollary is that we're also going to owe higher income taxes to the IRS. Fortunately, Roth IRAs consist of after-tax dollars so they will not be taxed a second time upon withdrawal. 

For those of us who expect to be in a higher tax bracket later in life (this is particularly true of young people), a Roth IRA can lead to significant tax savings. For example, the federal marginal tax rates in the United States are currently as follows for a single filer:

• $0 – $9,875: 10%
• $9,876 – $40,125: 12%
• $40,126 – $85,525: 22%
• $85,526 – $163,300: 24%
• $163,301 – $207,350: 32%
• $207,351 – $518,400: 35%
• $518,401 and higher: 37%

A younger individual who earns less than $40K per year, therefore, would likely only pay 12% taxes on their Roth IRA contributions. However, a high-income earner later in life who earns $200K annually would pay 32% on the same contribution amount. That can amount to thousands of dollars in foregone taxes if the investor contributes when they're a young low-income earner as opposed to an older high-income earner.

4. Lifelong Financial Literacy Skills

At best, a Roth IRA for a 20-year-old (or a 30-year-old for that matter) is not only a financial savings tool but also an educational resource. A Roth IRA for young investors inspires sound lifelong financial habits, especially the importance of delayed gratification. 

Watching your account balance grow month over month provides a sense of accomplishment and reward. For too many young people, their exposure to money management is little more than watching their checking account dwindle on a daily basis until their next paycheck, at which point the cycle repeats. Keeping tabs on an ever-growing Roth IRA teaches the value of patience and commitment. 

5. It Can Cover Education Expenses

Roth IRA account holders can withdraw funds without incurring a 10% early withdrawal penalty if the funds are used to cover verified educational expenses. These expenses could include textbooks, college tuition, school supplies, or even housing expenses on campus. Therefore, a Roth IRA is an invaluable asset for young people who are considering self-funding their higher education.

How to Open a Roth IRA When You're Young

There's no better financial savings tool than a Roth IRA for young investors. With a self-directed IRA, investors of any age can diversify their investment portfolio with equities, alternatives, and fixed-income assets to provide steady, strong growth in the years ahead. 

For true diversification, a self-directed IRA is necessary. These types of IRAs cannot be opened at your local Fidelity or Charles Shwab. Instead, these accounts require an IRS-approved third-party custodian. Only through a self-directed IRA can young investors gain tax-free or tax-deferred exposure to assets such as precious metals, cryptocurrencies, annuities, and real estate.

There are countless reasons to start a Roth IRA while young. So, what are you waiting for? To get started, learn more about Roth IRAs today.