Testing GPT-4 on a common financial advice question

Now that GPT-4 is available on ChatGPT Plus, we’re continuing tests to see how well it can provide financial advice. Our previous study evaluated GPT-3 on a very common planning scenario and found that it made a serious mistake. Building on that study, we conducted a new test of GPT-4’s capabilities to see if there had been any improvements in performance. Despite some progress, our latest findings show that GPT-4 still has significant limitations. It doesn’t yet meet the standards of a human.

Asking ChatGPT about IRAs

One of the most common questions any financial planner gets is whether a client should use a Roth IRA or a Traditional IRA. Let’s see how well ChatGPT 4 does in explaining the differences.

				
					Can you explain the differences between a Roth IRA and Traditional IRA?
				
			

A Roth IRA and a Traditional IRA are two types of Individual Retirement Accounts (IRAs) in the United States that allow individuals to save for retirement with certain tax advantages. Here are the main differences between the two:

  1. Tax treatment of contributions:
    • Roth IRA: Contributions are made with after-tax dollars, meaning you don't receive a tax deduction for the amount contributed in the year you make the contribution.
    • Traditional IRA: Contributions are made with pre-tax dollars, and you may be eligible for a tax deduction on the amount contributed in the year you make the contribution, depending on your income and other factors.
  2. Tax treatment of withdrawals:
    • Roth IRA: Qualified withdrawals are tax-free, as long as you meet certain requirements (such as being at least 59.5 years old and having held the account for at least 5 years).
    • Traditional IRA: Withdrawals are taxed as ordinary income, meaning you pay taxes on the amount withdrawn at your current income tax rate.
  3. Required Minimum Distributions (RMDs):
    • Roth IRA: There are no RMDs during the account holder's lifetime, allowing the account to grow tax-free as long as the account holder is alive.
    • Traditional IRA: RMDs are mandatory starting at age 72, meaning you must begin withdrawing a minimum amount each year based on your life expectancy and account balance.
  4. Income limits for contributions:
    • Roth IRA: There are income limits for eligibility to contribute to a Roth IRA. If your income exceeds the limits, you may not be able to contribute directly to a Roth IRA.
    • Traditional IRA: There are no income limits for contributing to a Traditional IRA, but there may be income limits for deducting contributions, depending on your income and whether you or your spouse are covered by a workplace retirement plan.
  5. Early withdrawals:
    • Roth IRA: You can withdraw your contributions (but not earnings) at any time without taxes or penalties. However, withdrawing earnings before age 59.5 and not meeting the 5-year rule may result in taxes and a 10% penalty, unless an exception applies.
    • Traditional IRA: Withdrawing funds before age 59.5 generally results in a 10% early withdrawal penalty, in addition to the taxes owed on the withdrawal amount, unless an exception applies.

Both Roth and Traditional IRAs can be valuable tools for retirement savings, but the best choice depends on your individual financial situation, tax bracket, and retirement goals.

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Overall, this response contains a wealth of information. However it is not particularly succinct or readable. To provide this answer to a financial planning client would not be good practice.

Asking which IRA is best for a hypothetical client

Now let’s test GPT-4 with a request for specific financial advice:

				
					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?
				
			

Based on your situation, you might consider contributing to a Traditional IRA for the immediate tax deduction. However, it's important to weigh the benefits of both options before making a decision.

Traditional IRA:

  • By contributing to a Traditional IRA, you can potentially lower your taxable income for the current year, which may be helpful if you need the tax deduction today.
  • Keep in mind that when you withdraw funds in retirement, the withdrawals will be taxed as ordinary income. If you expect your tax bracket to be higher in the future, this might result in higher taxes during retirement.

 

Roth IRA:

  • While you won't get an immediate tax deduction for your contributions to a Roth IRA, qualified withdrawals in retirement will be tax-free.
  • If you expect your tax bracket to rise, this could be advantageous as you won't pay taxes on the withdrawals during retirement when your tax rate may be higher.

Ultimately, the best choice depends on your individual financial situation, goals, and preferences. If the immediate tax deduction is crucial to your financial planning, a Traditional IRA may be a better fit. However, if you can manage without the tax deduction now and prioritize tax-free withdrawals during retirement, a Roth IRA could be more suitable.

You might also consider speaking with a financial advisor to help you assess your individual circumstances and determine the most appropriate strategy for your retirement planning.

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A concise and useful summary

ChatGPT did not provide a conclusive answer, but we can expect this. Our hypothetical client had contradictory objectives: a current tax deduction (Traditional IRA) and expectations of higher tax rates (Roth IRA). A good financial planner should ask for more information in this case.

Unlike our previous attempt, ChatGPT 4 correctly analyzed the effects of a changing tax bracket on the choice between a Traditional IRA and a Roth IRA. Last time, ChatGPT made a serious error in its response and confabulated the features of both kinds of accounts.

Conclusion: GPT-4 still falls short

While GPT-4 represents a significant improvement, it still falls short in providing effective financial advice. Even as advanced as they are, AI models lack the personalization and expertise required for well-tailored financial guidance. It remains crucial to seek a qualified human advisor who can offer personalized advice for your unique situation. 

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