Traditional vs. Roth: What Should I Tell My Clients?
Opening an IRA can be a sound way for your clients to save for retirement. But first, they’ll need to choose what type of IRA—Traditional or Roth—that they want to invest in. They may ask you for advice on which type of IRA is best.
You should not provide financial or tax advice. But to provide good customer service, you should be able to identify the following differences between Traditional and Roth IRAs to your clients so that they can make up their own minds.
Traditional and Roth IRAs share similar rules, but savers use these accounts in different ways.
An IRA, or an individual retirement arrangement, is a tax-deferred account that holds investments. Your clients may be eligible to make tax deductible contributions to a Traditional IRA, but will generally need to pay taxes when they withdraw the money. In contrast, individuals don’t get an immediate tax break when they contribute to a Roth IRA, but the earnings generated from Roth IRA contributions can be distributed tax- and penalty-free if certain requirements have been met.
Here’s how Traditional and Roth IRAs differ.
Traditional IRA
Contributions may reduce your clients’ taxable income for the year, giving them a tax break (depending on their modified adjusted gross income (MAGI) if they or their spouse are covered under an employer-sponsored retirement plan).
Distributions are generally taxed as ordinary income and may be subject to a 10 percent early distribution penalty tax if taken before age 59½. If their income is lower during their retirement years, this may help lessen the tax impact of taking a taxable distribution.
At a certain age, they will need to start taking required minimum distributions (RMDs) each year. For 2023, the RMD age is 73, and will increase to age 75 in 2033.
Roth IRA
To be eligible to make the maximum contribution amount for 2023, their MAGI must be less than $153,000 if single, or $228,000 if married, filing jointly. They may make a partial contribution for 2023 if their MAGI falls between $138,000 and $153,000 if single, or between $218,000 and $228,000 if married, filing jointly.
Contributions are made with after-tax dollars, which means they can’t claim a tax deduction when they contribute to their Roth IRA.
Qualified distributions are tax- and penalty-free and may be taken after they meet two conditions. First, they must meet a five‑year waiting period. This period generally begins on January 1 of the year for which they make their first Roth IRA contribution. Second, they must meet one of the following penalty-tax exceptions: age 59½ or older, disability, death, or a first-time homebuyer.
Nonqualified distributions may also be tax- and penalty-free, provided they do not exceed the amount that your clients have contributed to their Roth IRA.
RMDs are not required while Roth owners are alive (but are required for their beneficiaries).
So, what type of IRA should your clients invest in? It depends on their retirement goals and many other factors. Both Traditional and Roth IRAs allow individuals to grow their retirement savings by compounding their earnings over time, and often with similar investment options. Contribution limits are the same, too. Individuals can contribute up to $6,500 for 2023, plus a $1,000 catch-up contribution if they are age 50 or older.
If your clients want to learn more about Traditional and Roth IRAs, and to determine which would best benefit their financial goals, you can direct them to meet with a competent tax advisor. Or they can read IRS Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs), an online publication that provides helpful consumer information about IRA rules and eligibility requirements.
