"Traditional" accounts and Roth accounts are taxed differently — one provides a tax break now, and the other provides a tax break later.
Yesterday on Faith & Finance on American Family Radio, SMI's executive editor Mark Biller offered several reasons why putting some of your retirement money in a Roth is a wise idea. And he discussed new rules (taking effect in 2026) that will push higher-income retirement account holders — aged 50 and older — toward Roth accounts.
Mark and host Rob West also fielded listener questions about retirement account rollovers, lump-sum-versus-annuity decisions, and more.
Click the arrow below to listen. Scroll down for the transcript.
Faith & Finance airs each weekday morning on American Family Radio. A different version airs weekday afternoons on Moody Radio.
(For more radio appearances by members of the SMI team, visit our Resources page.)
Transcript
Rob West:
The average person makes 35,000 decisions a day. And one of them just might be "Traditional IRA or Roth" — which type of retirement account will put them money ahead in the long run?
Mark Biller joins us today to take a fresh look at the problem — and then it's on your calls at 800-525-7000. This is Faith & Finance on American Family Radio — biblical wisdom for your financial decisions. (theme music ends)
Well, if anyone can shed new light on the traditional versus Roth IRA decision-making process. It's Mark Biller — his team at Sound Mind Investing is always thinking about these sorts of things. He's also the executive editor.
Mark, great to have you back on the program.
Mark Biller:
Thanks, Rob. Good to be back with you.
Rob West:
Mark, as you well know, in this month's SMI newsletter you all have a great article to help folks make this decision. It's simply titled, Should You Use a Roth IRA, Even if You Prefer Traditional? So let's start with maybe why this is a good time to even ask that question.
Mark Biller:
Yeah, absolutely, Rob. So, a little background: Roth IRAs were introduced almost 30 years ago, in 1996, and since that time, while there have always been rules about who's allowed to contribute to a Roth account — no one's ever been required to choose a Roth over a traditional. Recently, a new law was passed that's going to change that. This new law is going to force some older, higher-income 401(k) investors to direct at least some of their contributions into Roth accounts.
And I should add, just for clarity, Rob, that this whole conversation this morning is also applicable to 403(b) plans, 457 plans, and Thrift Savings Plan people.
So, while this new law has been put on hold for a couple of years, it doesn't start for a few years here, it does raise a question that's worth considering for all investors who are eligible for a Roth account. And that is simply, regardless of your age or your income, "If you've been favoring a traditional account, would it be smart to direct at least some of your retirement contributions into a Roth account?"
Rob West:
And for background, Mark, in case some folks might not understand the difference between these two types of accounts, can you shed a little light on that?
Mark Biller:
Yeah, sure. First of all, whenever we're talking about "Roth versus traditional," these are specific types of accounts that provide very specific tax benefits for savers. And that's true whether we're talking Roth traditional in a 401(k) plan or Roth traditional with IRAs.
Now, people sometimes get confused, thinking a Roth investment is a certain type of investment and they're not. You can own most of the same things — stocks, bonds, mutual funds, cash, and so on — either inside or outside of a Roth or traditional account. It's just that if it's inside a Roth or traditional account type, you get specific tax benefits.
So, what are those benefits? Well, with a traditional IRA or a traditional 401(k) plan, the money that you contribute lowers your taxable income today. For example, if you put $5,000 in this year, you'll pay 2023 tax on $5,000 less income than if you hadn't made that contribution. Then, down the road, when you make withdrawals from that traditional account in retirement, you'll pay ordinary income tax on all the money as it comes out of that account.
A Roth IRA or a Roth 401(k) is basically the opposite. The money that you contribute today doesn't lower your taxable income now, but down the road in retirement, you won't pay any taxes when you take money out of that account.
Rob West:
Another way to summarize this might be, "Do you want to pay taxes now or later?" So, what's the conventional wisdom on how to make that decision?
Mark Biller:
Yeah, I think that's exactly the right way to frame it, Rob. And so the conventional wisdom that flows out of that is that Roth accounts tend to be great for younger workers because they're typically lower paid at that stage of their career. They have reason to believe that their income will be higher in retirement.
So the idea there is those younger workers want to pay taxes on their contributions now when they're in a lower tax bracket and then enjoy tax-free income and retirement when they might be in a higher bracket.
That whole situation basically flips for higher-income [earners] who are often older workers, especially if they have reason to think they may have lower income in retirement, as many people do. So the idea for those older workers is they want to take the tax break now on their traditional contributions when they're paying tax in a high tax bracket, and then hopefully, when they're taking withdrawals in retirement, they'll be in a lower tax bracket.
So this really boils down to trying to optimize when to pay the taxes when you're in a lower tax bracket.
Rob West:
And now it's those folks, the higher earners, Mark, who would prefer the traditional tax treatment, they're actually the ones being pushed by the new rules into the Roth contributions, right?
Mark Biller:
That's exactly right. So specifically, these new rules impact workers that are age 50 or older who are making what are called "catch-up contributions" that are above and beyond the normal amount that's allowed to be contributed.
Before these new rules came along, workers could choose either Roth or traditional as long as their employer plan offered both of those options. Now, with these new rules, starting in 2026, 401(k) plan investors who are over 50 and are earning more than $145,000, they'll have to direct any of these catch-up contributions into Roth accounts. And the reason for that is the government wants to collect more tax revenue sooner. They want the taxes paid upfront.
Now, of course, for those workers who are impacted by this, that's going to mean higher tax bills today or when they're making those contributions. So, this tax law change is pretty unwelcome news for some of those folks.
Rob West:
Yeah, there's no question about that. Now, is there a silver lining to all this?
Mark Biller:
There is — because as you've told your listeners for years, there's a lot to like about Roth accounts. And so much so that we're posing this question in this article this month: whether even people who aren't affected by this new law should consider putting at least some of their contributions into Roth accounts.
Rob West:
We're going to continue to unpack this. In fact, just around the corner, we'll dive into the pros and cons of both of these options to make sure we can help you make the right decision.
We're also taking your questions today on anything investing-related while Mark Biller's here. If you want to talk about where the market's headed, some of the cross-currents we're facing right now, looming recession, or your portfolio, give us a call: 800-525-7000.
Amos is in Pennsylvania. Go ahead.
Caller:
Yes, sir. My question is, I took $15,000 out of my 401(k) to help my son and his wife buy a property. And now they're slowly going to pay me back the money. That $15,000 included the taxes that the government took out of it, so I ended up with around $13,000 — and I've already paid taxes on that money.
[As I get repaid,] I want to put it back somewhere without any tax penalty. I mean, I thought about putting it back in my 401(k), and I said, "Wait a minute, I can't do that. I'll be paying tax on it twice!" So I just wanted to know where the best place to put that money back in to save it for retirement.
Rob West:
Great question. Mark your thoughts?
Mark Biller:
Yeah, Amos, are you still working? Are you earning income at this point?
Caller:
Yes, I am, sir. Yes. I'm still working. I plan on working for about another half a year or so.
Mark Biller:
Okay. Well, the reason that I ask that is a lot of the time, your eligibility to contribute to either workplace plans or IRAs is tied to whether you have at least that much "earned income" for the year.
So one option, Amos — like you said, you probably don't want to put it back in a traditional account and pay tax on that again down the road — but you could potentially put that money into a Roth IRA, even if you don't have a Roth IRA at this point. As long as you meet the income contribution limitations, you could put that money into a Roth IRA. You would be using after-tax income, which is what you have right now. But then that money would grow without additional tax being due on any of those earnings down the road. So that could be an option.
Of course, all the usual questions about timeframe, how long do you plan to have this invested — all of those things still apply. But the Roth IRA may be a convenient way to get around paying additional tax — if you were to reinvest that money today — down the road.
Rob, do you have thoughts on that?
Rob West:
Yeah, I love that idea. I think the only other one I might throw out is if you're not maxing out your traditional 401(k) — so you're putting in a certain percentage of your income, but you've got the ability to do more — you could actually bump it up and supplement your income with this money that is now in your checking account or savings account to make up for the gap. But that's basically a way of shifting that back into a tax-deferred environment. Does that make sense?
Caller:
Yeah. That all makes sense to me.
Rob West:
Yeah, so I mean, it's an interesting way you might say, "Well, I can't afford to put more into my retirement account. I need to live on that." Well, you could live on the money that you have in checking and spend that down, and thereby, you're kind of shifting that back into the tax-deferred environment if you're really looking for the pre-tax deduction. But otherwise, I think Mark's suggestion about the Roth IRA is certainly a good one.
Let's go to Matthew in Kentucky. Go ahead, sir.
Caller:
Good morning, gentlemen. So this is the first time I've heard about the new rule changes you're talking about, and it makes me wonder how should I be concerned about a future Congress passing a law to basically tax any Roth accounts on the backend. So if I pay taxes today, put it in, and at some point, they change the rules and want to tax it on the backend as well.
Rob West:
Yeah. Mark, your thoughts?
Mark Biller:
Yeah, 100%. Matthew, you're actually kind of reading our mind because what we're going to talk about as we go along in the program is some rationale for why the idea of diversifying your taxes — a tax diversification approach of having some of both types of these contributions — makes a lot of sense. And the reason for that is exactly what you're bringing up — the propensity of Congress to change the rules as we go.
Now, I've thought a lot about this over the years, as you might expect, and I think that probably the most likely way that that would happen is probably not an overt attack on Roth accounts, like we're going to now change the tax treatment on those directly. But what I do think is very possible down the road at some point is the government could implement some type of consumption tax where anything you buy is being taxed regardless of the source of that income. You see that a lot across Europe and different countries. They call it different things — VAT taxes, consumption taxes. The idea would just be that they're digging into our pockets a little more whenever we're making purchases.
And so if that were to be the case, then it's not going to be so much "this account type versus that account type," but it would obviously have implications for Roth IRAs as it would for traditional IRAs and any other source of income. So I think, Matthew, what we really have to look at is the possibility — and probably likelihood — that taxes will go up somehow in the future. Exactly what the complexion of that will look like is very difficult to predict. But because of that, we want to try to diversify our tax options [and] have money in these different account types that give us the most flexibility possible to respond to whatever those tax changes might be down the road.
If all of your retirement savings are going into traditional accounts, there are some good reasons to mix in some Roth contributions. One of the big ones is "no one knows the future." You don't know how long you're going to work, how high your income will be exactly in retirement. And if your retirement income turns out [to be] higher than you expect, you'll be glad to have some money in a Roth account that you can tap into without paying more taxes.
The other one is this idea of tax laws changing. And so, in fact, we've got a note in the article that these researchers at the University of Arizona say that since 1913, [Congress has] changed the tax rate for a couple, making an inflation-adjusted a hundred thousand dollars a year — get this — 39 times.
Rob West:
Wow.
Mark Biller:
So if rates do go up again in the future, having some Roth money will be very beneficial.
Rob West:
That's really interesting. All right, more with Mark Biller just around the corner. Plus your questions, 800-525-7000. We'll be back in just a moment. Stick around.
Rob West:
Great to have you with us today on Faith & Finance on American Family Radio. I'm Rob West, taking your investing-related questions today for Mark Biller. 800-525-7000. Mark is the executive editor at Sound Mind Investing. He joins us regularly on this program, and we're talking today about traditional versus Roth IRA in light of some changes in the tax code that will affect your future contributions.
Mark, what about the RMD, the required minimum distribution? How does that fit into this conversation?
Mark Biller:
Yeah, that's an important thing to think about, Rob, because once those RMDs kick in at age 73, that income can kind of have a domino effect that can push you into a higher tax bracket. And those required minimum distributions can also push you into a higher Medicare tier, which can mean that you're going to have to pay higher premiums for Parts B and D of Medicare.
The other thing that a lot of people don't think about is that if one spouse were to pass away, the survivor's new "single" filer tax status can push 'em into a higher tax rate even at the same or a lower income.
And in any of these cases that we're talking about this morning, Rob, it really would be great to have more money in a Roth account because Roths aren't subject to required minimum distributions. Of course, you're not going to pay taxes on any of that money coming out of a Roth, either. So, Roth accounts really have some big advantages.
One final one is if you're hoping to pass some of the money in your retirement accounts to beneficiaries, Roths tend to be advantageous.
So there's just a lot of different angles that argue in favor of having at least a little bit of your retirement savings in a Roth, even if you think overall the traditional makes a lot of sense for you.
Rob West:
Yeah, very good. So, the key here is to find the right balance between your traditional and Roth accounts in terms of contributions. And, y'know, we love a good rule of thumb, and you cited in the article some research that was done that produces — perhaps — a rule of thumb as you think about this. Share that with us.
Mark Biller:
Yeah, I thought it was really interesting, Rob. The article cites these two University of Arizona researchers. Their big idea again is that income tax rates may likely change in the future, and they've studied that in-depth, and they came up with a rule of thumb that they say produces near-ideal results. That rule of thumb is simply this: You add 20 to your age, and you put that percentage into a traditional account [and] the rest of it goes into a Roth.
So, let's walk through an example. A 40-year-old would add 20 to their age and contribute 60% to a traditional retirement account. The remaining 40% would go into a Roth.
Now, what they say is that the common advice for older workers to funnel most of their contributions into traditional accounts just doesn't adequately take into consideration the risks of these tax rates increasing. So they argue for this tax diversification as well.
We cite a couple of other reasons in that article to like Roth exposure, even for older workers. So, if this is a topic that really applies to you, I really would encourage listeners to look at the article. A lot of these things I know are difficult to just hear 'em once and understand them, but sitting there and walking through the examples, I think will really help people.
Rob West:
And perhaps this is a new idea that we need to have, or it's wise, to have two "buckets, "if you will, of your retirement assets growing — one that's pre-tax, one that's after tax, and that just gives you flexibility because of the unknowns. And this rule of thumb, and that's all it is — doesn't mean it's perfect — but is helpful that you simply add 20 to your age, put that percent in a traditional account, and then put the rest in a Roth. I think it's really simple and could be a great solution for folks.
All right, let's head back to the phones. Taking your questions today from Mark Biller. To Georgia, we go. Hi Al! Go ahead, sir.
Caller:
I have a pension plan from a former employer that was frozen five years before I left. It's been frozen for 10 years now. And now they say it's overfunded, and I guess they're wanting to put it into a different type of — annuity type thing. It'll still pay out when I'm 65, the same amount as it said before, but there's also an estimated lump sum.
And I'm 45. I was just wondering if I was able to roll over the lump sum, would it be more beneficial, or to keep it in and let it pay out when I'm 65 or 55? Of course, if I'm 55, it's much less.
Rob West:
Sure. Yeah. Mark your thoughts?
Mark Biller:
Yeah, Al, this is a big decision, or at least it can be depending on the amounts that we're talking about. A lot of times, people get toward the end of a career, they've got a big lump sum and they're making that lump-sum-versus-annuity decision. It's one of the more important financial decisions that they make.
So this is an area where — I'm sure Rob would agree — that if the dollar amounts are pretty significant to you, it can really be worthwhile sitting down with an advisor and walking through the specifics of your situation. We're going to try and give you some big principle guidelines here, but there's nothing that really compares to digging into the details of your specifics.
So generally speaking, with this decision, Al, what you want to try to do is figure out, "What is the rate of return, basically, of that annuity?" So, what is the annual return being represented by the amount of money you would be getting from the annuity?
So you figure that out by taking the payment value, what you're going to get on a monthly or annual basis, and then take a look at the principal, and you can figure out — if you're getting, just making up numbers, the equivalent of $10,000 a year and the principle is a hundred thousand dollars, you're getting essentially a 10% return. Now, it's usually much less than that, but you get the idea with that example.
So once you've figured out what that number is, then you can look at that and say, "Okay, is that a percentage that I could easily get on my own If I were to take that as a lump sum and invest it? Or would that be a difficult number for me to reach, trying to invest that on my own?"
For example, if you run those numbers [and] you're getting a 4% return. Well, right now, you could put money in T-bills and earn over 5%. So that wouldn't be a very attractive return. You might be tempted to take that lump sum and invest it yourself. On the other hand, if you're getting something upwards of 7%, 8%, 9%, that's pretty attractive, considering you have no risk or very little risk, and you're not having to do the investing yourself. So that's kind of the big picture of how to approach this.
We have an article, actually, that we wrote years ago, that's on our Sound Mind investing website. If you search on our site "lump sum versus annuity," you can find that article. It'll go into a little more detail, but that's how we generally approach that idea.
Rob, what else would you want to think about there?
Rob West:
Yeah, I think that's right. It's all about that internal rate of return. And then secondly is, "Am I comfortable taking the risk, or do I want to transfer that risk to someone else?" In this case, the pension administrator. And some folks like that.
In other cases, they'll say, "Listen, I have a gap between my monthly needs and my income, and this solves that gap, and that gives me peace of mind. So I'm going to prioritize knowing I at least have this the rest of my life."
But I think Mark's given you some things to think about here, Al. Thanks for your call.
Back with our final segment just around the corner.
Rob West:
Great to have you with us today on Faith & Finance on American Family Radio. I'm Rob West. Mark Biller here today, executive editor at Sound Mind Investing. We're talking "traditional versus Roth IRA" in light of some tax law changes. You can read the full article and take a deeper dive at soundmindinvesting.org.
Let's go to Texas. Hi, Grady. Thanks for your patience. Go ahead.
Caller:
Hey, no problem. Thank you guys for taking the question and Mark, and I'll try and make it fast so you can get to another one. And I'm a retired pastor, and I loaded up doubling up on the donation or the donations, whatever...
Rob West:
Contributions.
Caller:
...to the IRAs back before I retired. I'm retired now. I've got a 403 with about $120,000 in it. And what I was hearing is, like you're saying, well, maybe I should move that over to a Roth or something like that, or I'll have to move it over to a Roth.
I don't need it right now. Was waiting to maybe use it in case there was an emergency — health emergency — or something like that. So I'm just wondering, can I just leave it there and where it's at, or can I move it to someplace else where maybe it gets a better rate of return?
Rob West:
Yeah. Mark, money already in a 403(b)?
Mark Biller:
Yeah, I'm glad you called and asked this question, Grady. I think it'll help clarify it for a lot of people who may be wondering the same thing. So the big distinction here is for folks like yourself, Grady, who already have the money in the plan, what we're talking about today is really not something that you need to take action on today.
There's kind of a separate topic for some folks in a 401(k) if doing Roth conversions out of their traditional account makes sense, but that's really a separate topic. That's not really what we're talking about this morning.
Specifically, what this new law pertains to is people who are going to be making catch-up contributions, new contributions to their plans starting in 2026. And we've kind of expanded that — [the] bullseye of that target — to anybody who's making contributions currently to their plan whether it makes sense to diversify some of the traditional contributions into Roth.
But if you've already got your plan, Grady, and you've got it invested in a way that you feel is appropriate and you're comfortable with, I would not say that anything we're discussing this morning is a reason for you to feel like you've got to make changes to past contributions to a plan that already has been contributed to. This is really more targeted to people as they're making ongoing contributions and thinking through the best way for me to make new additional contributions.
So I think you can probably breathe easy there. It sounds like you're in a good spot, and there's really probably no reason to change that based on what we're talking about this morning.
Rob West:
Grady, is that helpful?
Caller:
Very, very much so. Thank you, man. I appreciate it.
Rob West:
All right. God bless you, my friend.
Mark, tie a bow on the discussion we've been having today just as we think about traditional versus Roth.
Mark Biller:
Yeah, Rob, I think the best way to think about this is most people don't think about taxes as a diversification kind of issue. But as with most investing topics, diversification is a very good thing. It's a principle we build on that we find in scripture. A lot of people know the Ecclesiastes 11:2 "diversification scripture." And it applies to more than just which investments you choose for your portfolio. It applies, as we've been talking about, to your tax treatment as well.
And since none of us know what the future holds, having a mix of both taxable and tax-free retirement accounts seems like a really wise approach. It gives us the flexibility to respond to future changes in the tax law [and] to changes in our own income and expense needs. So just, y'know, flexibility through that diversification is really the bottom line of what we're talking about today.
Rob West:
Yeah, very good. Mark, thanks for being here, my friend. We're grateful for you.
Mark Biller:
Thanks, Rob.
Rob West:
All right. That's Mark Biller. Sound Mind Investing is where you need to go. That's soundmindinvesting.org. Check out the article we've been discussing today. It's there for your reading. We'd love for you to check it out. It's called, Should You Use a Roth IRA, Even if You Prefer Traditional?
I'm Rob West. Thanks to my team today — Robert Youngblood, Robert Sutherland, and Devin Patrick. Couldn't do it without 'em.
We'll see you tomorrow. Come back and join us then. Bye-bye! (theme music ends)
AFR disclaimer:
The views and opinions expressed in this broadcast may not necessarily reflect those of the American Family Association or American Family Radio.
