Traditional Vs Roth IRA

Most people don't have a clear picture about these two financial vehicles and which might be most beneficial to them. So let's discuss ways to determine what might be right for you.

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Transcript Of Today's Show:

Speaker 1: Hey everybody, welcome to Plan with the Tax Man. Thanks for tuning into the podcast. This is Tony and I talk investing finance and retirement. Of course, Tony Mauro is an EA and a CFP with 23 years of experience in the industry. Well, probably closing in on 24 now, right?

 

Tony: It is, yeah.

 

Speaker 1: How you doing?

 

Tony: Not too bad.

 

Speaker 1: Hanging in there?

 

Tony: Mid-summer, yeah. It's nice, things are starting to open back up. So yeah, it's good.

 

Speaker 1: Well, good. I'm glad to hear that. Well, this week, I've got a pretty straightforward topic for us to hit, but it's one that gets a lot of questions, Tony. So I thought you could maybe break some things down for us. IRAs. We're going to talk traditional versus Roth, because it still confuses people. There's still folks out there who don't have a real clear picture, and that's okay, nothing wrong with that, on which they should be contributing to. So there's other things we could discuss, there's conversions and stuff like that. But for right now, let's just start with talking about the traditional IRA versus the Roth. Give us a quick breakdown of just the simple differences between the two types of accounts.

 

Tony: Sure. And before I do, what I want to disclose is both are useful, which we'll get to in just a moment.

 

Speaker 1: Okay.

 

Tony: But there's pros and cons of each, and one or both may or may not be right for everybody. So, it's a good topic. The reason I chose this topic today, I'm going to throw in a shameless promotion here, is I actually with another adviser, authored a little short book called Seven Steps to Protecting Your 401k/IRA from a Ticking Tax Time Bomb. It's just a little hundred-page read. If you want a copy, you can contact me. I'll give you one. But it goes into a lot of things in more depth than what we'll cover here. But the differences between the two accounts in essence, because people get confused about this at tax time, especially when we ask them, because they'll come in and say, "Well, I contributed to my IRA this year," and we have to ask, "Well, which one?" And I get this blank look, and then we have to go into that. And then they don't know, and they ask their advisor.

 

Tony: But the traditional IRA has been around a long time. That is where you're sticking money aside for retirement. And if you're not covered by an employer-sponsored plan, it comes out, and you can deduct it off your tax return. So it's a tax deduction, much like a 401k pretax contribution. And they came up with this Roth IRA, not that long ago in real terms, saying that, well, you can forgo, you can still put money into your IRA, but the trade off or the benefit of not taking a tax deduction now is we won't tax you ever on any of the earnings. You can pull it out. There's no tax on the earnings in the future. And so that's the main difference. I mean, there's some subtle differences as well, but we don't have time to get into those. But that's the trade off there, is the government's handing you a deal, now taking a tax deduction versus no tax deduction, I still put money in and I escape taxes forever.

 

Speaker 1: Okay. All right. So there's a couple of just the simple basics between the traditional versus the Roth. Why do you think so many people are contributing or have contributed more towards the traditional over the Roth, over the course of their investing lifetimes? Well, to be fair, the Roth's only been around since what the mid-nineties, I think.

 

Tony: Mid-nineties, yeah.

 

Speaker 1: But is it just because it's kind of been the norm, and that's kind of what's been beat into our head or what else is out there?

 

Tony: I think that that's been the norm, the traditional has been around longer, and then the normal, traditional advice has always been to take a tax deduction right now while you can, and you'll lower your income, lower your taxes. And since the money is growing tax-deferred, the old adage is, well, we'll pay taxes later, but you'll be in a lower bracket, theoretically, when you retire. Therefore, if you're in the 25, 30% bracket now, that you'll be lower than that when you retire. So that made sense to a lot of people, and still does for some.

 

Speaker 1: Well with the Roth being so powerful. Well, first of all, I guess maybe explain to us why the Roth can be so powerful. How about that?

 

Tony: Yeah. Well, the Roth can be powerful, because especially if you're young, but even for conversions and things like that, is taking and paying the tax now, when you know what your tax rate is, and then not having to worry about paying taxes on earnings ever in the future. And the reason we wrote the book is because we feel like in 401ks and traditional IRAs that this ticking time bomb, Uncle Sam, the government, they have a claim to everything that you have in those accounts.

 

Tony: You're not thinking about it right now, and what I mean by that is you're going to owe tax, or somebody is going to owe tax on those large balances. And that could be quite large if you have had a 401k or an IRA that you've contributed to for years and has really expanded. And I think when people start to sit down, we start running some numbers, especially when they say, well, I'm not going to be a lower tax bracket when I retire. I might be even at a higher tax bracket. And showing them how they can maybe convert some of that now into a Roth, or even start a Roth, and not worry about it, and having to pay tax on it. The differences can be enormous over time.

 

Speaker 1: Okay, very true. Very true. Now with the Roth being as I said, because it is so powerful, can you maybe give us an example to kind of illustrate, should we be looking at one. Is there any kind of way of looking at this and saying, okay, anybody from in this kind of demographic generally should definitely use a Roth or definitely not use a Roth? Because sometimes I think people also get a little confused that, and a lot of our demographic and listening audience is probably going to be 40 plus or so, in that range. So it gets a little confusing as to, well, should I convert and put everything into a Roth, or should I start doing one now, or just kind of give us some breakdowns of someone who maybe should contribute or should be contributing to a Roth.

 

Tony: It comes down, I think, a lot to personal preference. However, at the end of the day, when you run the numbers, they don't lie. I always like to say, as I put on my accountant hat. And really I think a Roth is going to be ideally suited for anybody young that's starting out investing's, got a long time. But even people 40 plus I think should be looking at Roths. And if they're still throwing money into an IRA, is using a Roth, and then maybe over time converting traditional IRAs over to a Roth so that you're basically taking the tax hit now, within limits. And then having that income later that is tax-free.

 

Tony: Because when we get to sit down with people, we try to show them in a financial planning meeting when we get going, is we try to divvy up their money into three pots. And that is money that's taxable now, which is generally income that they're making. Money that's taxable in the future, which is going to be these traditional IRAs, 401ks, other benefit plans. And then money that's never taxed. And there is not many things that go into that last pot, but the Roth IRA would be one. I always try to play with them and say, what else could go in that pot? And very few can even give me any other answers. And there's not many things that could go in there. And when they start seeing that, that you can build this pot of money that's going to be never taxed, they tend to like that. And then when you can show them some numbers based on what they're doing currently and how much that could add up to, that really turns the light on for them.

 

Tony: So I would say in answer to the question, basically anybody. Of course the next question is probably going to be well, what about traditionals? Who should go there?

 

Speaker 1: Right, basically, yeah.

 

Tony: You know, sometimes though when you run the numbers, depending on a person's situation and their appetite for, if they're just tax deduction hounds, the traditional might be better for, especially if they're already basically using say the Roth in their 401k, because there are Roth portions there. They may want to take a traditional IRA and defer some taxes to just stuff more money into something. That would be one, another one would be somebody that may want to just take the tax deduction now, and say again, they don't run any numbers, they just say, I want the tax deduction now. But if the numbers truly work out and they would actually pay less tax in retirement, that might be another option.

 

Tony: And what I'm pointing to on all of these is in this area, I think it's important that you get some professional help and run numbers on both types of scenarios so you could see what would benefit you most. Because it's going to be different for everybody. But generally everybody's opinion is always well, I'll stuff as much as I can in my 401k or my traditional IRA, and that everything is going to be set. And what we go over in the book and show some real life examples is, you can see by doing that, what a person would pay over their remaining life expectancy in taxes versus if they've done the same thing in a Roth. And generally the Roth wins.

 

Speaker 1: With so many people interested I guess, Tony, lately with conversions. And this has been going on since the tax reform, the current one that went into play in '17. There has been a big topic about, there has been a lot of conversation about converting over, because of the lower tax rates. Because with the traditional, as you've pointed out, at the end Uncle Sam is waiting. They're standing there going hello.

 

Tony: We're hand out.

 

Speaker 1: That's right. So is it beneficial to consider a conversion? It wasn't really on our topic list, but let's just kind of address it real fast, because it is such a big animal out there. That's a pretty powerful tool, should you choose to implement it correctly within your plan?

 

Tony: Yes. Well, and I think the conversions, what we do with clients is if they are thinking about converting, basically talking about the benefits, the pay Uncle Sam later, pay him now. The fact that it's never going to be taxed. At death that the income beneficiaries are going to get it tax-free, versus the traditional where there's going to be taxes due. There's no lifetime minimum distributions, things like that. And then another one that a lot of people forget about, is in a Roth you can definitely still make contributions after 70 and a half. A lot of people still want to do that. And in traditional you can't.

 

Tony: But after we go over that with them and say, all right, you're in this tax bracket, and you've got this much room before you jump into the next tax bracket. Maybe it would be a good idea to convert just that much this year and do that much every year. So you don't jump tax brackets and cost yourself more. But that way over a period of X, you'll have it converted over into a Roth. And then you're where you want to be, while we're taking advantage of these lower tax rates right now. Versus if you say you had $500,000 in a traditional IRA and you just went out and converted all of this to a Roth this year on your own not thinking. And the next thing you know, you got a tremendously large tax bill, because now you're in the top tax bracket for this year. So that's what you don't want to have happen.

 

Speaker 1: Gotcha. Okay. Well, when it comes to traditional IRAs versus Roth IRAs, as you mentioned earlier, Tony, sometimes it's a personal preference. But there is a lot of strategy that can be looked at, especially for retirees and pre-retirees, more so pre-retirees, I'd imagine. But there's still a lot of strategy that can be put into place with these, and they're a very powerful tool for your retirement savings. So it's best to really be working and talking through with an advisor in how it's going to fit within a plan that works well for your situation.

 

Tony: I would agree. I mean, there's a ton of strategy in them with the Roths from a tax standpoint, even though again, you'd get no tax deduction right now. And by utilizing some of that, like you said, I mean, it can make a world of difference over 10, 20, 30 years. So don't just go out and convert for sure. And if you just want to go start one and start contributing that's one thing, but definitely seek some advice before you convert a big balance.

 

Speaker 1: Well, I was going to ask you, since with you being a tax doctor, so to speak, when you mentioned, you don't get the tax benefit, obviously if you do the Roth. Is it much like with the houses now too as well? Where since we don't really with the 12,000 for, 24,000 for a married couple, is it really something you can even take an advantage of?

 

Tony: What's that, the IRA deduction?

 

Speaker 1: Yeah. I mean, is it kind of like the mortgage where it's probably not enough to matter, because you're not going to get over that 24,000. Let's say if you're married.

 

Tony: Well, with the standard deduction versus itemized, those are itemized deductions, the traditional IRA still ends up on the front page of the tax return. So you'll get that whether you itemize or not. So you still get that. But a lot of times though, people are already in their 401k in some form or fashion, or they'll make too much, and they can't contribute to the traditional. So it kind of phases them out that way.

 

Speaker 1: Gotcha. Okay. And again, that's why I ask the questions and you provide me the feedback, because sometimes it can be a little unclear for folks. And I know a lot of times ever since, especially with this new tax program that we've been on, your CPA or whatever may have said things like that to you. Well, you make too much, or it's not going to, whatever it is, it's not going to matter, because you're not going to get up over that 24,000 or so on and so forth. So if you're not working with somebody who is a CPA and a financial advisor, or has a CPA on the team, or whatever the case is, it's certainly a good idea to have kind of that complete team talking and working together. Because they do different animals, different things there. So the CPA is going to really help you with that portion of it, while the financial advisor is going to be able to help you with theirs, and so on and so forth.

 

Tony: Yeah. And I would throw out this stat out there, out of our many, many retail tax clients that we prepare tax returns for. So these are people that come in, we generally see once a year, they're kind of what I call, I mean, we know everything about them. So I always say, you're getting undressed financially in front of us, because it's all on there, what you're doing.

 

Tony: And it amazes me still that in today's age, we have as many people as we do that A. are either not participating in their 401ks, or if their company doesn't have a 401k they're doing zero for retirement. I mean, not even a Roth or a traditional, and these can be started for so little money, 50 bucks a month, and very little cost as well. And you need to get something going.

 

Speaker 1: Yeah.

 

Tony: We can't do it for people, but we advise them, it's something I look at when every tax return I check over and visit with people is, if they're not doing anything they need to get started. If they are, they get a little raise or if they can afford to throw five, 10 more bucks a month, it's only going to help them in the long run.

 

Speaker 1: Well, and then the long run is a lot of what we have conversations about, because we are talking about investing, finance, and retirement, and a lot of cases you're talking about for retirement as well. So if you have some questions about IRAs versus Roth IRAs, if you have questions about conversions or some of the topics we've covered today on the show, make sure you reach out and talk with Tony before you take any action. Give him a call at (844) 707-7381. That's (844) 707-7381. Don't forget you can also go to yourplanningpros.com to learn more. That's yourplanningpros.com. That's Tony's website, lot of good tools, tips and resources can be found there as well. And as always, we suggest, we ask nicely, I suppose, if you would be so kind as to subscribe to the podcast. We would certainly appreciate it. It's Playing with the Tax Man at whatever podcasting app you find most enjoyable, Apple, Spotify, Google, whatever platform you like.

 

Speaker 1: All right, my friend. Well, I'm going to let you go for this week. Thank you for breaking down a little bit for us the traditional versus the Roth IRA. I hope you have a great week and we will talk soon.

 

Tony: All right, take care.

 

Speaker 1: We'll see you next time here, folks, on Plan with the Tax Man with Tony Mauro of Tax Doctor, Inc. And we'll see you next time. Take care.