Despite facing a challenging financial environment marked by substantial student loan debt and rising inflation, many younger individuals, particularly Gen Zers and millennials, have made notable progress in building their wealth. Recent data highlights a significant shift: an increasing number of these younger generations are choosing to invest outside of traditional workplace retirement plans.
Surge in Roth IRA Participation
According to data from the U.S. Federal Reserve, analyzed by Boston College’s Center for Retirement Research (CRR), the percentage of households headed by a twentysomething investing in a Roth IRA has nearly tripled from 6.6% in 2016 to 19.2% in 2022. This substantial increase in Roth IRA participation is not mirrored among older age groups or in 401(k) participation rates.
The growth in Roth IRA usage among young adults is particularly pronounced among the top-third highest earners. The CRR attributes this trend to the advent of fintech platforms such as Robinhood, which have democratized access to financial instruments, making it easier for younger individuals to start investing. These platforms have lowered the barriers to entry, allowing more young people to invest in stocks and other financial assets with minimal initial capital.
Impact of the Pandemic
The COVID-19 pandemic played a pivotal role in this shift. Many young households, especially those with higher incomes, found themselves with more disposable income and time to invest. Stimulus checks and reduced spending on activities such as travel and dining out led to increased savings, which many chose to invest. Federal Reserve research indicates that the inflation-adjusted wealth of Americans under 40 grew by an astounding 80% between Q1 2019 and Q3 2023, primarily due to investments in the stock market.
Evan Potash, an executive wealth management advisor at TIAA, observed that the pandemic provided a unique opportunity for younger individuals. With more time on their hands and stimulus money available, many took advantage of market declines to invest. Additionally, younger people, who typically earn less at the beginning of their careers and are thus eligible for Roth IRA contributions, were well-positioned to benefit from this investment strategy.
Disparity in Wealth Growth
While this is positive news for higher earners, the benefits are not evenly distributed. CRR’s research found that only 4% of households headed by a twentysomething in the bottom third of the income distribution were investing in a Roth IRA in 2022, up from 2% in 2016. In stark contrast, 41% of those in the top third of the income distribution were investing in Roth IRAs.
Alicia Munnell, director of CRR, pointed out that technology has made it easier for those with financial resources and tech-savvy to save in tax-advantaged accounts like Roth IRAs. This ease of access has disproportionately benefited higher earners, leaving those at the lower end of the income spectrum behind.
Widening Wealth Gap
Other studies corroborate the growing wealth gap between the richest and poorest young people. Research published by the University of Chicago Press found that the wealthiest 10% of millennials hold 20% more wealth than the richest baby boomers did at the same age. Conversely, those at the lower end of the income spectrum have seen their wealth stagnate or even decline.
401(k) Plans vs. Roth IRAs
Despite the emphasis on 401(k) plans in financial media and advice, Americans hold a significant portion of their retirement assets in individual accounts. More young investors getting into the game early could help them grow their wealth significantly over time due to the power of compounding returns. Roth IRAs are particularly beneficial for young people because contributions are made with after-tax money, and investments grow tax-free until retirement. This structure is especially advantageous for those in lower tax brackets who do not need the immediate tax break provided by traditional IRAs or 401(k)s.
With federal income tax rates currently at relatively low levels, Roth IRAs represent an especially attractive option for young investors. This may change in the future if tax rates rise, making the Roth IRA’s tax-free growth even more valuable. Potash emphasizes the importance of starting Roth IRA contributions early to maximize the time for investment growth.
Early Investment Habits
The increase in IRA investments among higher earners is yet another indicator that young people are taking investing seriously and doing so earlier than previous generations. Prior research found that the average Gen Zer started saving for retirement at age 22, which is 15 years earlier than the average baby boomer began saving.
Conclusion
These developments underscore a significant shift among younger generations towards proactive financial planning and investing. Despite the broader economic challenges they face, many young individuals are leveraging technology and market opportunities to build their wealth early. This proactive approach could have long-term benefits, helping them to secure a more stable financial future. However, the disparities in investment behaviors between different income groups highlight the need for continued efforts to make financial education and investment opportunities accessible to all, ensuring that the benefits of wealth growth are more evenly distributed.