Artificial intelligence has come a long way in recent years, and today we have chatbots that can provide complex responses to complex questions. One of the most advanced AI chatbots available today is ChatGPT, a large language model trained by OpenAI. In this article, we’ll explore how effective ChatGPT is at providing financial advice and whether it’s ready to replace human financial advisors.
Asking ChatGPT about IRAs
One of the most frequent questions any financial advisor gets is whether a client should open a Roth IRA versus a Traditional IRA. Let’s see how well ChatGPT does in understanding the differences and advising a sample client.
Can you explain the differences between a Roth IRA and Traditional IRA?
Yes, I can definitely help explain the differences between a Roth IRA and a Traditional IRA.
A Roth IRA and a Traditional IRA are both individual retirement accounts that offer tax-advantaged savings for retirement. However, there are several differences between them:
- Traditional IRA contributions are made with pre-tax dollars, which means that you can deduct the contributions from your taxable income in the year you make them. The money in your Traditional IRA grows tax-deferred, meaning you don't pay taxes on the earnings until you withdraw them in retirement.
- Roth IRA contributions are made with after-tax dollars, so you don't get a tax deduction for the contributions you make. However, the money in your Roth IRA grows tax-free, meaning you don't pay taxes on the earnings when you withdraw them in retirement.
- Traditional IRA contributions have no income limits, but there are income limits for deductible contributions. For 2023, if you are covered by a retirement plan at work, the deduction for contributions to a Traditional IRA is phased out if your modified adjusted gross income (MAGI) is between $69,000 and $79,000 for singles and heads of household, and between $116,000 and $136,000 for married couples filing jointly.
- Roth IRA contributions have income limits. For 2023, the ability to contribute to a Roth IRA phases out if your MAGI is between $140,000 and $155,000 for singles and heads of household, and between $208,000 and $218,000 for married couples filing jointly.
Required minimum distributions (RMDs):
- Traditional IRAs require you to start taking required minimum distributions (RMDs) at age 72. This means that you have to start taking money out of your Traditional IRA and paying taxes on it, whether you need the money or not.
- Roth IRAs do not require you to take RMDs during your lifetime. You can keep the money in your Roth IRA for as long as you like and let it continue to grow tax-free.
- Traditional IRA withdrawals before age 59 1/2 are generally subject to a 10% penalty, in addition to regular income taxes on the amount withdrawn.
- Roth IRA contributions can be withdrawn at any time, tax-free and penalty-free. However, if you withdraw earnings before age 59 1/2, you may have to pay taxes and a penalty on those earnings, unless you qualify for an exception.
- Anyone with earned income can contribute to a Traditional IRA, regardless of age.
- Roth IRAs have age restrictions. You can contribute to a Roth IRA at any age as long as you have earned income, but you cannot contribute to a Roth IRA if your income exceeds certain limits.
It's important to note that both Traditional and Roth IRAs have annual contribution limits, which are currently $6,000 per year for individuals under age 50 and $7,000 per year for individuals age 50 and older. Additionally, both types of IRAs can be invested in a variety of assets, including stocks, bonds, mutual funds, and exchange-traded funds (ETFs).
So far, so good. This is an excellent summary of the difference between the IRAs. Now let’s try a specific example of a financial planning question.
Given these differences, which one should I choose if I am 30 years old and I expect my income tax bracket to rise but need a tax deduction today?
If you expect your income tax bracket to rise but need a tax deduction today, a Traditional IRA might be a better choice for you than a Roth IRA. Here's why:
Since Traditional IRA contributions are made with pre-tax dollars, you can deduct the contributions from your taxable income in the year you make them. This can help lower your taxable income and your tax bill for the current year.
Assuming your income tax bracket will be higher in the future, you may benefit from taking the tax deduction today when you are in a lower tax bracket. This is because when you retire and start withdrawing money from your Traditional IRA, you will pay taxes on the withdrawals based on your income tax bracket at that time. If you are in a lower tax bracket in retirement, you may pay less in taxes on the withdrawals than you would have paid on the contributions today.
However, it's important to remember that every person's financial situation is unique, and there may be other factors to consider when deciding between a Traditional IRA and a Roth IRA. It's always a good idea to consult with a financial advisor or tax professional before making any investment decisions.
ChatGPT made serious mistakes
There are two major mistakes highlighted above in bold text. Let’s look at the 2nd one first:
“If you are in a lower tax bracket in retirement…”
We specifically asked about a higher tax bracket, so why did it discuss a lower bracket? This is one of the pitfalls of large language models—their accuracy depends on the data used to train them. Perhaps in the dataset used for ChatGPT, more text was written about clients retiring in a lower tax bracket.
“Assuming your income tax bracket will be higher in the future, you may benefit from taking the tax deduction today when you are in a lower tax bracket.”
This doesn’t make sense. If your tax bracket will rise into retirement, it’s better to pay the lower tax today and invest the money in an after-tax Roth IRA, so that the retirement distributions aren’t subject to the higher rate. This is one of the most basic differences between the two options. To quote Investopedia: “If you think you’ll be in a higher tax bracket when you retire, a Roth IRA may be the better choice.” If ChatGPT makes such a simple mistake, it probably wouldn’t do very well with complex financial planning scenarios.
Conclusion: Humans remain superior
While this chatbot is undoubtedly an impressive feat of artificial intelligence, it’s not ready to fully replace human financial advisors. Our testing revealed that ChatGPT financial advice can be hit or miss, with significant inaccuracies and inconsistencies in its recommendations. Nevertheless, it can help with background information for common questions. AI can certainly assist human advisors in their work, but for now, it’s best to stick with human financial advisors for reliable, personalized financial advice.