Gen Z is doing better financially than baby boomers at their age and saving for retirement

The evidence is accumulating that Generation Z is on a sound fiscal path, at least when it comes to personal finances.

Largely thanks to a tight labor market, the typical 25-year-old Gen Z member — those born between 1997 and 2012 — has a household income of more than $40,000. That's more than 50% above baby boomers at a comparable age, according to a recent Economist article on the generation.

Gen Z is also doing relatively well saving for retirement. Vanguard reported last year all generations increased their participation rate in 401(k)s, but Gen Z saw the largest jump. Thirty percent of employees ages 18 to 24 participated in their employer's 401(k) plan in 2006. The participation rate rose to 62% in 2021.

"Automatic enrollment and the rise of target-date funds are reshaping retirement plan behavior for all generations, but those innovations are having the greatest impact on younger workers: the millennials and Generation Z," according to the Vanguard generational study.

I'd like to see even higher retirement savings participation rates among Gen Z, of course. Looking ahead, the numbers should improve since newly created 401(k) plans must auto-enroll employees with a minimum contribution of 3% of annual pay starting in 2025. Contributions will automatically increase by 1% a year until they reach a 10% or 15% savings target. (The real need is to bring anyone working for an employer who doesn't offer a retirement plan into a low-cost, well-diversified retirement savings option with automatic enrollment and target date funds.)

Young adults saving for retirement are tapping into one of the simplest and most formidable tools in finance: the power of compounding. Founding Father Benjamin Franklin, always good for a pithy insight, captured the essence of compounding: "Money makes money," he wrote. "And the money that money makes, makes money."

Take this simplified example. Let's say your investments return 6% yearly, and you invest $10,000. If you earn 6% on a $10,000 investment, you'll make $600 the first year. The second year starts with $10,600. By the 20th year, your balance will have increased by more than 200%. Plus, in an employer-based plan, you make regular contributions through payroll deduction and receive the employer's matching contribution.

The compounding process seems slow at first. The longer savings compounds, the better. For the typical 25-year-old, assuming a retirement target age of 65, 40 years is plenty of time for compounding to work its math. Compounding is one reason diligently investing for the long haul pays off eventually.

Chris Farrell is senior economics contributor, "Marketplace"; commentator, Minnesota Public Radio.