Why millennials are behind when it comes to saving for retirement — and what they can do to get ahead

The cards seem to be stacked against millennials when it comes to making the most of their finances, between inflation now being at its highest rate in nearly 40 years, the cost of owning a home becoming increasingly expensive and student loan debt preventing many from saving for short- or long-term financial goals. 

While millennials as a whole are making an effort to save for the future, they are still behind previous generations when it comes to building up their retirement savings. According to Fidelity's 2020 Retirement Savings Assessment study, millennials (born between 1981 and 1996) ranked higher than Generation X-ers (born between 1965 and 1980) on the retirement preparedness scale, in part because they had increased their savings rate from 7.5% to 9.7% over the past two years.

So why do millennials lag behind their elder cohorts when it comes to retirement savings? Below, Select explores this question further by speaking with Angie Chen, assistant director of savings research at the Center for Retirement Research at Boston College.

In a recent Millennials Readiness for Retirement study, conducted in 2021 by the Center for Retirement Research, Chen and fellow researcher Alicia Munnell found that millennials had a lower net wealth-to-income ratio between the ages of 28 and 38 compared to that of previous generations.

"This study I did follows a study we did earlier that showed that they [millennials] were behind on a lot of indicators, including earnings, labor force [participation], marital status and home ownership," says Chen. "Now that there's a cohort of millennials that are in their late-20s and late-30s, they seem to have caught up on a lot of these key metrics that we would care about."

Since so many millennials graduated from college during the dot-com bubble in the early 2000s and the Great Recession in 2008, they were thought to have worse labor market outcomes than previous generations.

Chen notes that economic downturns negatively impact new graduates as they tend to have difficulty finding jobs or end up taking lower paying jobs shortly after graduation — research also indicates when new graduates enter the workforce during a recession, their earnings are lower.

The study also found that by the time most millennial men and women are in their 30s, they have caught up to earlier generations on metrics such as labor force participation and earnings. Millennials also have higher college education rates than previous generations and similar home ownership rates to Generation X-ers and baby boomers (born between 1946 and 1964).

So, if millennials are more educated, have similar rates of home ownership as previous generations and their earning potential overall hasn't been hindered by two economic downturns, why are they still behind on saving for retirement?

It turns out student loan debt was the primary reason why many millennials were behind in building up sustainable wealth. According to the study, 40% of millennial households between the ages of 28 and 38 had student loan debt that amounted to more than 40% of their income.

Millennials may have taken on student loans, but they're also more likely to be college educated, so that generally puts them on a higher lifetime earnings trajectory, explains Chen.

"It's not surprising to see early on in their careers that they would have lower net worth and potentially sort of less wealth and retirement savings," says Chen. "What we don't know is whether that will continue."

According to Chen, this could become a major issue since millennials also have a longer life expectancy than their elder cohorts and may end up receiving fewer Social Security benefits in the future. The 2021 Social Security Trustees report warns about reduced benefits beginning in 2034, stating that retirees will only receive 78% of their benefits after that time unless Congress resolves the long-term funding issue.

Though some personal finance experts like to attribute millennials' lack of retirement readiness to their wild spending habits — you know, splurging on lattes and avocado toast — there are a number of systemic factors that, in reality, impede their ability to save money for the long term. 

A National Institute on Retirement Security survey points to a shift from defined benefits plans, such as pensions, to defined contribution plans, such as 401(k)s and individual retirement accounts, as one of the main reasons why millennials are falling behind when it comes to saving for retirement. 

The 2014 survey found that only 55% of millennials were eligible to participate in a retirement plan through their employers while 77% of Generation X-ers and 80% of baby boomers were eligible for employer-sponsored retirement plans.

Now that most companies are not providing pension plans to their employees, the responsibility for saving for retirement falls on the individuals — some experts recommend that you aim to save 15% of your income for this exact reason.

Fortunately, when you contribute to your retirement account you're able to use that money to invest into the market, and thanks to compound interest your money can grow significantly over time. For example, if you started investing into a retirement account at age 30 and you're investments yielded a 9% average yearly return (the S&P 500 has yielded about 10.5% on average since 1957) you'd need to invest just $370 per month to reach $1 million by age 65.

If your employer offers a 401(k) match, your first priority should be to take advantage of it, as you're essentially getting an initial 100% rate of return on your retirement contributions. Beyond your 401(k), you might also want to consider opening an individual retirement account if possible, preferably a traditional or Roth IRA, which both have unique tax-advantages.

With a traditional IRA, individuals don't have to pay taxes until they take distributions in retirement. Depending on your income and whether you're offered a retirement plan through an employer, your traditional IRA contributions may be considered tax deductible, meaning they can reduce your taxable income which, in turn, can reduce the amount of money you'll owe in taxes.

A Roth IRA, on the other hand, is an after-tax retirement account, so individuals have to pay taxes on their upfront contributions, allowing their money to grow tax-free over time. Plus, you won't have to pay any taxes when you withdraw, unlike a traditional IRA. While a traditional IRA has no income limit, a Roth IRA is only available to single people making under $144,000 or married couples filing jointly making less than $214,000.

Select ranked Charles Schwab and Fidelity Investments to offer the best IRAs and best Roth IRAs. Vanguard, Betterment and E*TRADE also ranked high on those lists.

If you're new to investing and aren't sure which Exchange-Traded Fund (ETF) or index fund to invest in, you may want to opt for a robo-advisor, which uses an algorithm to invest your money and will periodically buy and sell assets on your behalf. When you sign-up for a robo-advisor, you'll have to fill out a questionnaire asking you about your short-term and long-term savings goals, and the robo-advisor will create a portfolio for you, typically comprised of different stock and bond funds.

Select ranked Betterment and Wealthfront among the best robo-advisor services.

Saving for retirement can be a daunting task for millennials burdened with student loan debt. While many millennials have bounced back from low labor market participation rates during the dot-com bubble and Great Recession, it's too early to know whether student loan debt will be a long-term drag on their ability to save for retirement. For now, only time will tell.

Catch up on Select's in-depth coverage of personal finance, tech and tools, wellness and more, and follow us on Facebook, Instagram and Twitter to stay up to date.