Retirement

Revisiting Roth vs. Traditional with Bud Kasper and Corey Hulstein, CPA

September 11, 2023

Revisiting Roth vs. Traditional with Bud Kasper and Corey Hulstein, CPA

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Revisiting Roth vs. Traditional with Bud Kasper and Corey Hulstein, CPA Show Notes

It’s hard to believe that we’re approaching the 100th episode of The Guided Retirement Show. But before we release that special episode later this season, we want to reflect on The Guided Retirement Show’s first two episodes. They were released back in 2019 and focused on Roth vs. traditional IRAs.

Along with looking back at what all has changed in the tax code that impacts the Roth vs. traditional decision, we need to take a forward-looking approach during this discussion. That’s because there are new tax laws scheduled to start in 2026 after the Tax Cuts and Jobs Act sunsets.

There a lot of things that need to be considered when choosing between Roth and traditional. Modern Wealth Management Managing Directors Dean Barber and Bud Kasper and Director of Tax Corey Hulstein, CPA are going to review those considerations.

In this podcast interview, you’ll learn:

  • The Difference between Roth vs. Traditional
  • Tax Rates Are Scheduled to Go Up in 2026 After the Tax Cuts and Jobs Act Sunsets
  • Some of the Key Changes with SECURE 2.0
  • The Ins and Outs of the Roth Five-Year Rules

Bud and Corey’s Initial Stances on Roth vs. Traditional

Dean has been excited to have this Roth vs. traditional discussion with Bud and Corey for a long time. Those of you that know Bud know that he’s all about the Roth. In fact, he’s a self-proclaimed Rothaholic and has been since 2010. That’s when income limits were completely phased out. Before 2010, if you made more than $100,000, you couldn’t convert to a Roth account.

“I am Bud Kasper, and I am a Rothaholic.” – Bud Kasper

In just about every conversation Dean has with Bud about Roth vs. traditional, Bud says the Roth is the way to go. Corey, however, always tries to be a voice of reason when breaking down Roth vs. traditional debate. Corey understands where Bud is coming from, but says that just about every CPA’s answer to Roth vs. traditional will be, “It depends.”

“You can’t talk to a CPA without getting that answer every now and then. Generally speaking, Roth is going to be the way to go, especially when it comes to the retirement phase of life and estate planning as well. But for those who are still working in those high-income brackets, there’s a spot for traditional 401(k)s and IRAs.” – Corey Hulstein, CPA

The Difference between Roth vs. Traditional

Now, that we’ve covered Bud and Corey’s initial viewpoints on Roth vs. traditional, let’s dive right into the difference between the Roth and traditional.

Traditional IRAs

With traditional IRAs or 401(k)s, you get a tax deduction when you put the funds into the IRA account. None of that money that you put into the account is going to be taxable in the current year. That money grows over time tax-deferred. None of the interest, dividends, or gains inside of that account are taxable.

But once we get to the distribution phase of life, we take those funds out to begin living on. That’s when the taxation happens, meaning all that income that has grown over time is now going to be taxable on the date of distribution.

When Dean and Bud started their careers in the 1980s, they were taught to tell everyone to put all their money in a tax-deferred account. That’s because when they got to retirement, they were going to be in a lower tax bracket. They could defer it and then pay taxes at a lower rate in the future. Of course, that didn’t turn out to be the case.

“The intention was good upfront, but once people shoved enough money into those accounts, that didn’t come to fruition. People stockpiled enough assets that they needed to start living on, which drove them into the higher tax brackets when factoring in pensions, Social Security, and then IRA distributions.” – Corey Hulstein, CPA

Roth IRAs

With the Roth IRA, you put the money in and pay the taxes on it before it goes in. All your earnings are still tax-deferred, but when you go to take the money out, it’s tax-free.

Let’s get some help from the original Rothaholic to further explain the Roth IRA. Bud has met so many people who have been proud of what they’ve saved for retirement. They’ll tell Bud that they have X-amount and all of it is saved in a traditional IRA. Well, the problem is that they don’t really have X-amount because it hasn’t been taxed yet.

Bud says that retirement is time of your life that people really don’t want to pay any more taxes because they’ve paid taxes their entire lifetime. Well, the retirement savings game changed in 1997 when the Roth IRA was introduced. Then, in 2010, the income limits that we just mentioned were phased out.

“That gave us an incredible opportunity because everybody could put money into a Roth IRA account. Any money that comes out of a Roth will not be federally taxed. And in certain states—Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, and Washington, and Wyoming—have no state tax either. It’s a win-win situation for those folks.” – Bud Kasper

Reviewing the Drastic Changes from the SECURE Act

We’ve covered the SECURE Act at great length over the past four-plus years. Before the SECURE Act, you could inherit an IRA or Roth IRA and simply take Required Minimum Distributions based on the single life expectancy table for inherited IRAs and therefore stretch that money out in that IRA or that Roth over their lifetime.

The SECURE Act changed that. All the money now must to come out of traditional and Roth IRAs within a 10-year period. The reason the Roth is better than the traditional is not just because it’s tax-free. It’s that regardless of the date of death of the original IRA owner, there are no

RMDs in the first nine years, but all of it must come out in 10 years. On a beneficiary Roth IRA prior to SECURE Act, there were RMDs every year.

“Why is that big deal? Because we get 10 full years as a beneficiary of tax-free growth. Then, in the 10th year when that comes out, it’s nontaxable.” – Dean Barber

Looking Back on the Beauty of Stretch IRAs

That’s an incredible thing when you think about it. But remember what it was before. It was tax-free growth for the rest of your life. Think about what that could compound into for a family member of a person who had a Roth. A son or daughter of a Roth IRA owner could have 30-35 more years of life where they could stretch it out and take advantage of letting the money grow tax-free. That was quite a deal until the SECURE Act came along.

401(k)s: Roth vs. Traditional Contributions

At Modern Wealth, we can all participate in 401(k)s. Let’s hear from Corey about whether he’s contributing to the Roth or traditional portion and why. Context matters here, so Corey wants you to know that he’s 30 years old. The question he asks of people who are in a similar situation is if they expect their income to go up or down on an annual basis. Hopefully, the answer is up and you’ll continue to earn more throughout your career.

“I’m currently doing 100% Roth contributions on my portion. The way things are structured at Modern Wealth is the employer match is going into a traditional 401(k). Depending on what my contribution number is, it ends up at roughly a 50-50 split between Roth and traditional. But my contributions are 100% Roth.” – Corey Hulstein, CPA

A Roth Match in the Future?

One enticing provision in the SECURE Act 2.0 was that the ability for a Roth match appears to be in the works. Congress has given zero direction on how that’s going to work, though. We don’t know from the company or employee perspective how that’s going to work or when it will go into effect.

“It looks like 2024 is a possibility that this can start happening. It’s likely larger plans than smaller companies just from the logistical nature and all the background work that goes into it.” – Corey Hulstein, CPA

Remember that the employer level, they receive a deduction from their taxes for any money they’re putting into your 401(k). That is a taxable benefit to the employee. But when it goes into that traditional 401(k), none of the funds that go in there are taxed. The company gets a deduction, and the employee doesn’t need to pick that up as income.

When we switch that formula over to a Roth contribution at the employer level, it’s likely going to be taxable compensation to the employee when the contribution goes in. There needs to be some incentive for the employer to continue doing it.

Bud Wants You to Become a Rothaholic

You can probably already guess which side of his 401(k) that Bud is contributing to. He’s also contributing 100% to Roth because he’s a Rothaholic. You can Bud as a member of our Rothaholic Club by clicking here. On top of that, Bud is a converted Rothaholic.

Understanding Roth Conversions and What to Consider

Outside of making a contribution while you’re working, the way you get money into a Roth account is to convert a traditional IRA to Roth IRA. You do need to pay the tax on the conversion. There’s a science to that from a planning perspective.

“For example, let’s say you want to convert $10,000. If you convert that based on your current income, will that put you in a higher tax bracket? What tax will you need to pay? But remember, the tax that you’re paying today will be the only tax you’ll pay on that money for the rest of your life.” – Bud Kasper

Last, But Not Least, Dean Is Also a Rothaholic

After asking Corey and Bud their respective decisions on Roth vs. traditional 401(k) contributions, Dean confirmed that he’s also a Rothaholic. He’s contributing 100% to the Roth portion of his 401(k) as well.

“I know that the day that I choose to no longer work—which I have no idea what this could be, it’s quite aways from now—that my income isn’t going to be any lower at that point than it is today.” – Dean Barber

Roth vs. Traditional: Why the Traditional Could Make Sense

While Dean, Bud, and Corey are contributing 100% to the Roth, they want to share scenarios when the traditional 401(k) can make more sense for some people. Let’s say that someone is 55 and in their peak earning years. They’ve done a good job saving inside their 401(k) and accumulating money outside of their 401(k) in a normal brokerage account. They have money in the bank and plan on retiring early at 60.

If that’s the case, they might want to consider putting money into the traditional side of their 401(k) to get a deduction at that top tax bracket. Then, in the first several years of retirement, Dean would encourage them to delay claiming their Social Security and live off the money that’s already been taxed.

What Tax Bracket Are You in?

When they’re doing that, they can convert from the traditional IRA to the Roth IRA up to the top of the 12% or 22% bracket to where they’re getting money into the Roth at a lower tax bracket than if they were contributing to their 401(k) in the Roth.

Hopefully, that shows you why Corey said that context matters. In our Roth vs. traditional discussion, it’s critical to keep in mind that the tax law change that’s scheduled to take place in 2026. Generally, Corey encourages clients in the 10%, 12%, 22%, and 24% brackets to go with the Roth IRA or 401(k). It’s when people are in the get 33%, 35%, 37% brackets where the traditional could make more sense.

Dean, Bud, and I have saved outside of the 401(k) and the IRAs. They have flexibility to access funds at a low cost to them once they get to that retirement phase of life, allowing them to convert at those lower brackets.

“That’s the Catch 22, isn’t it? If you don’t have the after-tax money that you saved in some other place—a bank, whatever the case may be—how are you going to pay the conversion tax?” – Bud Kasper

There’s a Science in the Roth vs. Traditional Decision

Don’t ever put money into any type of an account until you know what the rules are going to be to get the money out of the account. When making the Roth vs. traditional decision, you need to step into the future.

“You need to create a plan that takes you up to that distribution phase, that phase in your life where you’re no longer working but your money’s working for you. You’re now asking your money to provide income. What are the tax ramifications based on today’s tax law?” – Dean Barber

We know the Congress can’t keep their hands off the tax laws and they’re going to keep changing. The point is that we need to follow the rules based on the laws that are on the books today. That’s how you make your decision.

Don’t automatically do the Roth if you’re young and the traditional if you’re in your peak earning years. Like we said, there’s a science to this. It’s all about creating an income stream and understanding how the different sources of income will be taxed. Your objective is to pay as little in taxes over a lifetime, not just in one year.

How Does Social Security Factor into Your Retirement Cashflow?

For many people, Social Security is a big part of that retirement income stream. Social Security by itself isn’t taxable, but at a certain level of income, that changes. However, sense the Roth income is tax-free, it’s not a part of the equation with making more of your Social Security taxable.

“Essentially the taxation of Social Security benefits is a sliding scale. If all you have in retirement is Social Security benefits, likely a low percentage of that benefit is considered taxable. As you add additional sources of income, like IRA distributions, that is going to drive up that taxability percentage of the Social Security benefits.” – Corey Hulstein, CPA

Again, that’s going to be a different conversation for different ages. Corey isn’t expecting on Social Security benefits when I’m 75. If you’re younger, you need to build out what your income stream realistically looks like 30-40 years from now. If you’re in your 50s or 60s, you need a financial plan to know how to make decision such as Roth vs. traditional.

Going Back to Higher Tax Rates

With being uncertain about what Congress could do next with tax law, Bud says that’s all the more reason to do Roth conversions. If Congress does nothing between now and 2026, the Tax Cuts and Jobs Act will sunset on December 31, 2025. That means on January 1, 2026, we would go back to the higher tax rates from 2017.

We look closely at Roth conversions every year to see if it makes sense and it doesn’t always make sense. Corey and Dean looking into doing Roth conversions for a single woman late in 2022. However, doing Roth conversions for her would’ve made 85% of her Social Security taxable when it wasn’t before. Her RMDs at age 73 were never going to throw her into a higher tax bracket than what she is today.

“In that instance, it didn’t make sense to do the Roth conversion. There wasn’t going to be any benefit for her. Now, there may have been a small benefit for her beneficiaries, but it wasn’t something that was going to impact her life.” – Dean Barber

Working Together with a CFP® Professional and CPA

When you optimize the result, one of the things that you want to remember is that it’s best to convert when you’re no longer employed and you have that W-2 income. This is where the coordination between CPAs and CFP® Professionals comes in.

“We need to understand what bracket we might be in with the conversion, which is going to be taxable. We need to plug all this in to maximize the results without triggering any other taxes on Social Security, Medicare premiums, and even education with 529s.” – Bud Kasper

What’s IRMAA?

Bud mentioned triggering more taxes on Medicare premiums. We want to expand on that with discussing IRMAA—the income limits that start causing your Medicare premiums to go up. IRMAA stands for Income Related Monthly Medicare Adjustment. It’s another thing to consider if you’re going to do Roth conversions post 65. Technically, post 63 since there is a two-year lookback.

“If your income as a married filing joint couple is right around $200,000 or less (these numbers move with inflation each year), you’re going to be at the base rate of Medicare. But it is a cliff system, meaning that if we go a dollar over their threshold for that year, we are jumping into a higher level of Medicare premiums. The coverage doesn’t change. You’re just paying more for the same coverage.” – Corey Hulstein, CPA

Corey calls this a shadow tax when discussing it with clients because you don’t see it on the tax return anywhere. And it doesn’t impact you for two years. But at the end of two years, you’ll get a letter from the Social Security Administration saying your premium might go up $70 per month, $140 per month, or even $500 per month. It varies.

When looking at Medicare for a married filing joint couple, it adds around a 3% to 4% tax on any conversions once you get into those higher levels of Medicare. So, it’s a definite consideration.

The First Roth IRA Five-Year Rule

As we continue our Roth vs. traditional discussion, we need to touch on the Roth IRA five-year rule. When the Roth IRA was introduced 1997, Congress said that in order to get the tax-free benefit from the Roth, the money needs to be in the Roth for the longer of five years or until you turn 59½. So, you can’t put it in at 58 and then take it out when you turn 59½ because it hasn’t been five years yet.

A lot of people get confused with thinking that they can’t touch any of that money in that five-year period without incurring taxes. But that’s not true. The five-year rules when it comes to a Roth IRA are one of the more confusing areas of the tax code. There are two five-year rules regarding a Roth IRAs. One rule is related to the earnings or growth of the Roth IRA and one is related to a penalty on the Roth IRA.

“Regarding the earnings, a Roth IRA needs to be funded for at least five years before you can access the earnings of the account. The thing to note here is that a Roth 401(k) is not a Roth IRA. If you roll funds from a Roth 401(k) to a Roth IRA at retirement, technically all you can access in that first five years are the original contributions that you put into the account. You can always access your principal or contributions.” – Corey Hulstein, CPA

An Example to Help with Understanding the First Five-Year Rule

Let’s say that somebody retires and has $500,000 in the Roth 401(k), but only $250,000 of that was contribution and the other $250,000 was growth or earnings. If they retire, roll that to a Roth IRA, the first $250,000 they spend won’t be taxed because you’re going to take out earnings first.

“I could see someone saying that they have $500,000 in the Roth portion of their 401(k) and will just roll that over to a Roth IRA when they retire and use that money to buy a beach house. But in that example, $250,000 of that would be subject to tax.” – Dean Barber

The Second Roth IRA Five-Year Rule

The other Roth IRA five-year rule is more related to conversions. It’s geared toward a pre-59½ penalty because you can access our contributions before 59½ without penalty, but can’t access any of the earnings.

What are the contributions? Well, you can create a basis inside of a Roth account by doing a conversion. But what used to happen is people would need money from their IRA accounts. And what they would do is they’d take it from the traditional account and convert it over to Roth.

By doing that, they would establish basis. Then, they would immediately take the basis or the principal out of the Roth account and essentially bypass the 10%, pre-59½ penalty. This is where that second five-year rule comes into play with closing that loophole.

“On any conversions, this only applies to people who are pre-59½ because that’s when the 10% penalty is applicable. But any conversions that you do pre-59½ have a five-year clock before that basis can be touched without penalty.” – Corey Hulstein, CPA

The Rothification of America

While Dean, Bud, and Corey believe that the Roth is one of the best parts of the tax code, they’ve been asked by people if Congress is going to take the Roth away. Bud doesn’t think so because as of now, they’re $32.7 trillion in debt. They need money all the time.

“They’re getting more money by having people who are Rothaholics. They get revenue to help offset some of the expenses they have. The problem is that Congress doesn’t know when to stop.” – Bud Kasper

America’s IRA Expert Ed Slott is calling this the Rothification of America. Congress started doing the SEP Roth and SIMPLE Roth and allowed the 529 to go to the Roth. They don’t want the tax deductions today. They’d rather have the revenue than having somebody deduct the money when it goes into traditional 401(k)s.

“Generally speaking, Congress is going to be short sighted. Their job relies on reelection every two to six years. That’s part of the puzzle. SECURE Act 2.0 has doubled down on a lot of what we see with Roth IRAs. They’re safe for the time being. We’ve seen a big push by Congress to expedite income and wanting people to contribute to Roth accounts.” – Corey Hulstein, CPA

We’ve Never Had Double Taxation

There is there is one scenario in which Dean can see where the Roth IRA wouldn’t be a good idea. He’s going to go back to the whole conspiracy that government is going to get people to pay the taxes and then they’re going to change the rules and they’re going to make this taxable later so that people pay tax twice.

We’ve never had double taxation. There’s never been a scenario where the same dollars taxed twice through the same individual. So how could they do it?

“The only way that I can fathom that they could tax that Roth money is by completely eliminating the income tax and replace it with a national sales tax five, 10 years from now. In that instance, you would be paying taxes as you spend that Roth money.” – Dean Barber

If you are of the opinion that we could come into a national sales tax and completely eliminate the income tax, then converting to a Roth would be a horrible idea. Then you’d want to leave everything in traditional and have a bigger pot of money that you can spend.

Could the Roth Become Taxable?

Corey has had several conversations with clients about what the future of the Roth and if it could become taxable. But Corey’s rebuttal to that is reminding people who is tracking basis inside a Roth IRA after you’re 59½. The answer is nobody.

“There’s no requirement to track it. So, how do you know what has and hasn’t been taxed? The only scenario I can see in that example is if we’re not doing a sales tax type of situation and they want to start taxing Roths, how can you argue what should be taxed? It needs to be the fair market value of the account on the date that that goes through. All that growth that’s happened in theory would then still be tax-free.” – Corey Hulstein, CPA

I know last year we did more conversions than we’ve ever done because of what you said. It’s going to sunset on December 31, 2025, and I think we’re probably going to have more this year because it’s narrowing down from that point of opportunity.

Summing Up Our Roth vs. Traditional Discussion

If it were possible to have 100% Roth, a lot of people would love to have 100% Roth. But for people who have been working for any number of years, that’s virtually impossible because all company match goes into the traditional side.

“You don’t see very many people with all Roth, but I do have a few clients that are enjoying retirement with all Roth money. Remember in 1997, when the Roth originally came out, if your income was below $100,000, you could convert and then spread that tax liability out over a five-year period.” – Dean Barber

Ed Slott told a great story about a couple that was teaching in 1997. Ed suggested that they go on a one-year sabbatical, not have any income so that they could convert their entire retirement accounts to Roth IRAs and spread that out over a five-year period. Their coworkers thought they were crazy, but it was a brilliant move.

Don’t Forget About How QCDs Factor into the Roth vs. Traditional Decision

One important final note is remembering the role that Qualified Charitable Distributions play in the Roth vs. traditional discussion. Dean and Corey have had several scenarios this year where people want to do conversions, but want to leave a certain amount of money in the traditional because they know they can get it out of the traditional with the Qualified Charitable Distributions. It never gets taxed because it goes straight from the IRA to charity and doesn’t show up on the tax return at all.

“What better way to give money to charity than from a traditional IRA? For anybody that’s charitably inclined, it’s never a good idea to convert all of it to Roth.” – Dean Barber

Roth vs. Traditional: Which Is Best for You?

The bottom line is that the traditional and the Roth have a place in people’s financial plan. Make sure your advisor understands what your goals and objectives are. Figure out the best plan for you to contribute to and to withdraw from so that you accomplish the main objective, and that is to pay as little tax as possible over your lifetime.

If you have any questions about Roth vs. traditional, we’re happy to help you. You can ask us your Roth vs. traditional questions during a 20-minute “ask anything” session or complimentary consultation with one of our CFP® Professionals by clicking here. We can meet with you in person, virtually, or by phone. It’s critical to understand that your situation is going to be unique to you when deciding between Roth vs. traditional, so we’re looking forward to helping you figure out which is best for you.

Watch Guide

00:00 – Introduction
03:07 – Breaking Down Roth and Traditional
07:05 – SECURE Act and SECURE 2.0
09:25 – 401(k)s and Roth or Traditional
16:52 – Why Roth vs. Traditional Matters
18:06 – Even Social Security Needs Factored In
19:20 – Do Roth Conversions Make Sense
21:03 – IRMAA & Medicare Considerations
22:31 – The 5-Year Rule & Roth Conversions
27:29 – The Rothification of the US
28:32 – One Scenario a Roth Doesn’t Fit
31:06 – The Bottom-Line on Roth vs Traditional

Resources Mentioned in This Article

Investment advisory services offered through Modern Wealth Management, LLC, an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management, LLC, an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management, LLC, does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.