Is it ever too early to start investing? Experts say no—and Gen Z is listening. For those born in the 1997–2012 years, the time to act is now. As this generation starts their careers, they are diving into the investing pool and finding strong traction with IRAs. In a 2022 study by Fidelity, the number of Gen Z IRA investors rose 71% compared to Q4 2021.

Let's dive into what a Roth IRA is and why its design makes them appealing to Gen Z investors.

How a Roth IRA Works

A Roth IRA is an individual retirement account that accepts contributions using after-tax dollars. Because they are taxed upfront, there is no tax burden when money is withdrawn later in life. A traditional IRA does the opposite—contributions are made with pretax dollars, which lowers your yearly income for tax purposes. While a Roth IRA doesn’t help you in the year when you invest, it could save a lot of money in tax payments later.

Who Can Have a Roth IRA?

Anyone of any age can have a Roth IRA as long as they meet certain conditions:

• They must have earned income.
• Contributions can’t exceed the amount of income earned in a year.
• Their modified adjusted gross income (MAGI) can’t exceed the amount set by the Internal Revenue Service (IRS) for that year.

For example, if 14-year-old Sienna earns money from a part-time restaurant job, she is eligible to contribute to a Roth IRA. If she earned $5,000 that year, she can contribute up to $5,000. However, she can’t contribute money given to her as gifts or an allowance.

Contribution Limits

Just as there are limits on what type of money you can contribute, there are limits to how much you can contribute based on your MAGI. For 2023, you can contribute up to $6,500 ($7,500 if age 50 or older).

These contribution amounts may be limited based on your MAGI. If you earn too much money, your contribution amount may be reduced or eliminated entirely. These contribution limits also depend on your filing status, and earners that fall between the lower thresholds and upper thresholds below may be eligible to make partial contributions:

• Single Taxpayers: For 2023, single earners may make up to $138,000 and make full Roth IRA contributions. If the single earner makes more than $153,000 in 2023, they can not make Roth IRA contributions.
• Married Filing Joint Taxpayers: For 2023, MFJ taxpayers may make up to $218,000 and make full Roth IRA contributions. If the MFJ taxpayer makes more than $228,000 in 2023, they can not make Roth IRA contributions.
• Married Filing Separate Taxpayers: MFS taxpayers may make partial contributions to their Roth IRA when their MAGI is between $0 and $10,000. Taxpayers whose MAGI exceeds $10,000 can not make Roth IRA contributions.

Benefits of Roth IRAs

Roth IRAs offer the opportunity to pay your taxes up front, eliminating taxes on withdrawals when you retire. For those who believe they are in a lower tax bracket now than they will be when they retire, this can be a huge advantage. Since most of Gen Z are just starting their careers, it’s easy to assume that their earnings and tax bracket will only go up from here.

The ability to withdraw your contributions anytime is also a huge asset. You can withdraw the money you’ve contributed to your Roth IRA at any time—you’ve already paid taxes on it, so there are no fees, penalties, or taxes. With a limit of $6,500 in 2023 (excluding catch-up contributions), the money you contribute is essentially in a hard-to-access holding account as its earnings are reinvested.

Roth IRAs are friendlier to entrepreneurs. If you can prove that you earned income, you can open a Roth IRA, regardless of age. Many other investment tools have age requirements that eliminate young people altogether.

You also don’t have to withdraw the money at any certain time—or ever. Unlike traditional IRAs that require minimum distributions at age 73, Roth IRAs allow you to keep the money indefinitely. You can even pass it on to your heirs untouched, and they can inherit the money tax-free as well.

Drawbacks of Roth IRAs

Ideally, your investment will earn money as well. Withdrawing your earnings has a different set of standards. To withdraw your earnings without penalty before age 59½, you must meet certain conditions, such as the following:

• You are using the funds to buy or build your first home.
• You have a permanent disability.
• You are the recipient of the Roth IRA from the original owner’s death.

Earnings may be withdrawn for other reasons, but they will be taxed at your current income rate, as well as incurring a 10% penalty. Earnings may be withdrawn penalty free to pay for education expenses for you, a spouse, or a child, but the withdrawal will still be taxed.

Although tax-free income in your retirement years is ideal, lowering your tax burden now is also attractive. The money you save in taxes now can be invested for the future.

The Bottom Line

As they enter the workforce, Gen Z has a huge opportunity to leverage their lower tax bracket to harvest wealth in their retirement years. Roth IRAs may not lower your taxes now, but tax-free income at retirement can make a huge difference, depending on how the tax code changes. Roth IRAs also offer flexible investment options for those thinking of buying a home or sending a loved one to college.