account options

As an advisor, it’s important to have a thorough understanding of the most popular retirement account options available to your clients. Equally important, you should have a firm grasp on your clients’ retirement goals, as well as their anticipated assets and expenses during the golden years.

Your conversations should most certainly cover taxes, as this will be an important factor when comparing retirement account options. For example, if a client’s taxes are likely to be lower in the future, perhaps due to a lower income, deferring taxes may be beneficial and the client might consider funding a Roth account. If, however, a client’s taxes are likely to be higher, paying the taxes now may be the best move. These clients might consider traditional retirement plans. Given that future tax scenarios are uncertain, it is wise for clients to diversify their tax exposure—to help them optimize their after-tax income in the future.


Employer plans – 401(k)s

There are two main types of 401(k)s available today: traditional and Roth. Depending on their employers' offerings, your clients may or may not have access to both. The main difference between the two is the tax treatment:

  • Traditional 401(k): Payment of taxes on both contributions and earnings is deferred until retirement.
  • Roth 401(k): Taxes on contributions are paid up front. Withdrawals of both contributions and earnings are federal income tax free, provided the withdrawal is "qualified."

Advisor Tip: Although 401(k) assets do not immediately add to your AUM, helping your clients understand 401(k)s and the key differences between traditional and Roth accounts increases the likelihood that they will roll over to an IRA with you when the time comes to switch jobs or retire.

Key differences between traditional & Roth 401(k)s
Traditional 401(k) Roth 401(k)
Contributions Pre-tax contributions reduce current taxable income After-tax contributions do not affect current taxable income
Withdrawals after age 59½ Taxed as current income Tax-free for investors who have had the account for at least five years
Required minimum distributions April 1 of the year following the year the owner attains age 70½ or separates from service, whichever is later


Individual plans – IRAs

A traditional IRA can help clients who do not have an employer-sponsored plan save for retirement. Even individuals with an employer-sponsored plan may be eligible to invest in IRAs, depending on their income. A newer option, the Roth IRA, allows your clients to make after-tax contributions and, later, withdraw the assets free from federal income tax, provided the withdrawal is "qualified".

These personal retirement plans are available to anyone who has compensation (for Roth IRAs, your compensation must be below a certain amount as discussed in the table below) during the year. Compensation includes wages, salaries, fees, tips, commissions and taxable alimony. Also, if only one spouse works, the non-working spouse can still contribute to his or her own IRA, even though he or she has no earned income.


Key differences between traditional & Roth IRAs
Traditional 401(k) Roth 401(k)
Eligibility Individuals under age 70 1/2 with earned income
Non-working spouses under age 70 1/2 who file a joint return with a working spouse
Individuals of any age with earned income and an adjusted gross income less than (2016 limits, phase-outs apply):
Married/joint — $184,000
Single — $117,000
Married/separate — $10,000
Contributions After-tax dollars with a possible deduction taken on tax return After-tax dollars with no deduction allowed
Withdrawals After Age 59½ Taxed as current income Tax-free for investors who have had the accounts for at least five years
Required Minimum Distributions April 1 of the year following the year the owner attains age 70½ None for owner


To Roth or not to Roth?

A traditional account may be better if:

  • Your client needs a lower tax bill now.
  • His or her employer does not match contributions to the Roth 401(k).
  • His or her plan does not allow loans against Roth 401(k) balances.

A Roth account may be better if:

  • Your client expects his or her income tax rate to be higher in retirement than it is now.
  • He or she can afford to contribute the maximum amount to a Roth 401(k).
  • He or she is eligible to make Roth IRA contributions.
  • It is likely he or she will not need the entire account for retirement income. A Roth IRA allows clients to avoid required minimum distributions (RMDs), preserving the assets for a beneficiary who can "stretch" the money tax-free. A Roth 401(k) can be rolled into a Roth IRA without additional tax implications. However, the five-year holding period from 401(k) does not transfer to IRA.