A Gen Y investing trend could portend a sea change for retirement investing and planning.
Younger investors are choosing Roth IRAs over traditional IRAs in startling numbers, according to recent data. Investors under 34 years old have a surprising eight times as much money in Roth IRAs than traditional IRAs, according to T. Rowe Price customer data as of year-end 2013.
That's even more dramatic than the shift shown in an IRS analysis released last year. Using data from 2010, the report showed that investors between the ages of 15 and 35 had four times the amount of money in Roth IRAs as in traditional IRAs.
The trend reflects in part the reality of younger workers' lower paychecks (and lower tax brackets) but also widespread interest in saving, based on distrust of the financial industry, and greater awareness of the Roth IRA strategy. The younger the investor, the greater the ratio of Roth assets to traditional IRA assets, according to the IRS data.
"The overall point is that Roth is the appropriate choice for more people," says Stuart Ritter, an in-house CFP at T. Rowe Price. "This is one time when parents should be taking their cue from millennials."
For most millennials, Ritter says, forgoing the tax deductions now to receive tax-free money in retirement is an easy decision. Generally, he points out, these younger investors are in a lower tax bracket now than they will be when it comes time to tap into the funds from the IRA.
"I would expect this trend to continue as more people become aware of it," Ritter says.
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The growing preference for Roths stems from a few factors, say advisors: tax benefits specific to workers at the beginnings of their careers, the generation's savings-oriented mentality, and a broader cultural awareness of Roths among friends and family. Young investors seem to be getting information about Roths from parents, financial blogs and social media, says Brandon Moss, a CFP and managing director at United Capital in Dallas who has made a specialty of working with younger clients.
In many cases, he adds, the first question a millennial will ask in a client meeting is about Roth IRAs. "Advisors are definitely pushing Roths on younger folks, but that demographic is so information heavy, they come in with at least some decent knowledge," Moss says. "If a millennial is seeking out a financial advisor, they have done some semblance of homework."
Yet other advisors point out that younger clients' knowledge tends to stop at the creation of the accounts. "There is a real lack of knowledge in what you can invest in," says Evan Welch, CIO of Antaeus Wealth Advisors in Boxborough, Mass.
Welch says he's "a little impressed" by the roughly half of millennial clients who come in with knowledge of the retirement planning strategy. But few seem to know what to do with the account once they set it up, he notes, with many simply too conservative when it comes to putting money into their Roth IRAs.
"There is a fear of being too aggressive long term," Welch says. "They have grown up during the financial crisis and they have become hesitant to invest."
In fact, he says, many of his younger clients assume that they can only invest their Roth IRA funds in CDs: "It's a huge misunderstanding."
It's possible that the new focus on Roths is actually boosting younger workers' overall retirement preparedness.
Total retirement assets for investors age 15-35 were more than $5 billion in 2010, compared with $3.9 billion for investors 15-35 in 2004. (Retirement savings have been rising overall; total U.S. retirement assets grew to a record-high $16.642 trillion in 2013, according to the Retirement Market Insight Report 2014 by Spectrum Group.)
Many younger clients feel that, "No one will take care of me but me, and I should save money," Moss says. "They're not doing it because they're savvy, but because they're scared."
Yet some advisors worry that those retirement assets aren't as secure as one might imagine. "Someone will come along and realize there is a lot of money out there and come up with a clever idea to market to the mindset of millennials," says Greg Peterson, director of investment research at Ballentine Partners in Waltham, Mass.
One concern is that a budget-strapped federal government could renege on the Roth's promise and impose more taxes or restrictions on withdrawals later on -- something Moss dismisses as unlikely. "I would have to think there would be some grandfather clause," he says.
There's also the worry that millennials may, despite the best of intentions, wind up sabotaging their own savings efforts. Because investors can make Roth withdrawals without penalties for first-time home purchases or for educational purposes, Peterson explains, Gen Y investors may find themselves tempted to drain the accounts well before retirement.
"It's a human temptation and a likely temptation," he says. "I would urge them to resist unless it is an absolute last resort."
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