Roth vs. Traditional IRA Investments: Don't Let the Tail Wag the Dog
Slott and Levine noted that investments that have a high return and that are also tax inefficient are often best placed in the Roth, because it has tax deferral and tax-free growth.
“So, if you have inefficient investments, meaning investments that produce a lot of capital gains or interest or dividends each year, it’s good to have those inside a tax-deferred wrapper so that you’re not paying tax on those dollars each and every year,” Slott observes.
What About Taxable Accounts?
Both the Roth and traditional IRA are popular for their ability to shield gains from income taxes along the road to retirement, but that doesn’t mean that taxable brokerage accounts should be overlooked. In addition to providing more liquidity, such accounts also have tax-related virtues of their own.
For example, brokerage accounts can be used to engage in tax-loss harvesting to help clients offset current or future capital gains. This can be especially important if their other assets are highly appreciated from a low basis.
“Generally, the taxable account is going to be for lower return and more efficient investments — for example, municipal bonds,” Levine observed. “Taxable accounts can also be useful in the context of estate planning, because these accounts generally get the step-up in basis upon the death of the original owner. That’s a big deal.”
The Bottom Line
Decisions in this area boil down the client’s list of investments, Levine and Slott conclude.
“Let’s say you have 10 investments,” Levine said. “You can go through a process and rank them, one to 10, and decide what would be best in the Roth, what’s best in the traditional account and what’s best in taxable — based on some of the factors we’ve discussed.”
Pictured: Jeff Levine and Ed Slott