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Retiring early is a goal for many people, but it can be difficult to achieve without careful planning and the right financial strategies in place. One of the most effective ways to build wealth and achieve financial independence is through the use of a Roth conversion ladder.
What is a Roth Conversion Ladder?
A Roth conversion ladder is a strategy that allows you to convert your traditional IRA or 401(k) account into a Roth IRA over several years. The conversion process involves moving funds from a pre-tax account (such as a traditional IRA or 401(k)) into a post-tax account (a Roth IRA) and paying the applicable taxes on the converted amount.
The reason for doing this is that Roth IRAs offer tax-free withdrawals in retirement, unlike traditional accounts that are taxed upon withdrawal. By converting traditional retirement savings into a Roth account, you can take advantage of the tax-free withdrawals and potentially pay less in taxes overall throughout your retirement years.
How Does a Roth Conversion Ladder Work?
To use a Roth conversion ladder, you must first have a traditional IRA or 401(k) account. You then convert a portion of your traditional account to a Roth IRA each year, paying taxes on the amount converted each year. It is important to pace the conversions so that the taxes paid do not push you into a higher tax bracket.
After you have completed the conversion process, you can then use the Roth IRA for withdrawals in retirement. Because you have already paid taxes on the converted funds, the withdrawals are tax-free.
Can You Retire Early with a Roth Conversion Ladder?
A Roth conversion ladder can be a powerful tool for early retirement planning. By converting a portion of your traditional IRA or 401(k) to a Roth IRA each year, you can build up your tax-free retirement savings over time. With careful planning, you can use this strategy to retire early and have a more tax-efficient retirement.
Before using a Roth conversion ladder, it is important to consult with a financial advisor to determine if this is the best strategy for your specific retirement goals and financial situation. You should also consider other factors, such as your retirement income needs, tax bracket, and estate planning goals.
In conclusion, a Roth conversion ladder is an effective way to build wealth and achieve financial independence, especially for those who want to retire early. If you are interested in using this strategy, work with a financial advisor to determine if it is right for you and to create a plan to maximize its benefits.
Thanks for watching everyone! If you could give this video a LIKE, that would really help out the channel. Also let me know what you think of this early retirement technique down below. Cheers!
If I did the conversion in 2020, is it available 2025 or 2026 Calender year?
After 5 years, wouldn't it be the same to ignore the roth and just take the money out of the traditional to live on?
I thought if you already have a roth IRA account before the conversion action, then the "5 yrs waiting" is waived. Do I understand that right?
You explained this so well! I feel much smarter! Question– can you still work during those 5 years? If you leave your employer and stop contributing to a 401k?
Thank you very much for this video! Very clear and straightforward
Awesome explanation! Thank you
Even if you are over 59.5 you still need to convert some of your reg IRA every year, and wait as long as possible to withdraw from your ROTH. The plus of working part time in retirement is if you earn at least the $7000 that you are allowed to contribute to your ROTH you can still make contributions. Find something you enjoy doing and work part time at it and continue to invest in your ROTH. That has been my plan and I retired at 54 and still converting my reg IRA and still contributing to my ROTH at 61.
Excellent teaching, Jake. I learn a ton from you. You're a gifted teacher.
Thank you
Thank you
Really liked the video and great step by step explanation. Only comment is that IRS requires Roth withdrawls in very specfic order (contributions, conversions and then earnings) so techinically you would have to remove all contributions (green bucket) before starting on removing conversions (yellow bucket) , but at that point as you described, the ladder is already established and will take you to 59.5. Again great video!
Jake, why wouldn’t someone do this process just to get more funds into the Roth IRA to help the tax free growth of the earnings bucket?
This seems like another version of the mega back door roth which ends with getting more money into the Roth IRA
Forget age 59 1/2 and use 72T
Never knew about this, cheers!
IM confused . My advisor say I can begin to withdraw once I left the company in the same year I turn 55 not necessarily after I turn 55..
We can no longer do backdoor conversion once we rollover 401K to traditional IRA, based on prorata rule. Can you clarify ? May be a video will help.
If I have been contributing to a Roth IRA for more than 5 years and do in-service conversion from 401k to Roth 401k, then quit my job and roll over the Roth 401k to Roth IRA, does the 5 year rule applies to the money I converted from 401k to the Roth 401k which I finally converted to Roth IRA?
One of the major issues with the FIRE approach is that most of them aren't even looking at Health Insurance premium just like in this video. Many end up buying health insurance through Obamacare exchange and its premium is based on household size and income at that time. The net effect is that the increase in health insurance premium acts like an additional layer of taxation thus the concept where about $50,000 being a sweet spot is incorrect for most people leaving the workforce before Medicare age of 65. Some people have health insurance after retirement from their employer but that's more of an exception than a rule. After receiving Social Security, the tax bracket gets heavily distorted as the percentage of the Social Security Income that gets included varies with the formula 1/2 Social Security + other income and your tax filing status (single or married). That tends to drive the effective tax bracket sometimes above 40% even in relatively low income range. Those in a rather fortunate situation in retirement in the higher income range end up getting a higher Medicare premium for Part B and drug coverage (Income Related Monthly Adjustment Amount – IRMAA). Those whom are married often ignore IRMAA until they are hit with it after one spouse dies. This is why IRMAA is often called a widow tax trap. The other major factor with Roth Conversion planning is that the longer you postpone and presumably, with modest amount of successful investing, the tougher it is to convert that balance to the Roth at a reasonable cost. It's easier to convert $100,000 now than convert say inflation adjusted equivalent of $400,000 decades later. Some people like using mortgage calculation to approximate the yearly conversion amount for a given present balance to convert to a Roth. I prefer using a Monte Carlo Simulation because it is closer to reality and gives a range of possible outcomes.
This is the best video about Roth Conversion, 401K to Roth IRA, etc. I wonder why this one does not have a million views? lol.
Only one case of climacophobia in 8 months.. not bad!
Sweet so I could do this, if I had $1,000,000 in a traditional IRA just missing that little piece lol. Feel like i'm going to be way behind on my retirement since I just opened a ROTH IRA at 34 and just now started putting in $5,000 a year.
This is THE best video on Roth ladder I have watched, and I have watched A LOT on the topic
no question interesting and it CAN work, and mostly it should work, but in the end, still OVERsimplistic and DANGEROUS.
works only if the stock market goes on as it did the last ten years, the decade 2000-2010 would have "killed" you. additionally, no inflation considered: you dont take out 52000, 52000, …, but 52000-adjusted-for-inflation-from-year-to-year. Approximately you should therefore calc with max:7.8% instead of 9.8%.
now with the 2000-2010 decade, in an artificial, more dramatic, but not unimaginable scenario:
** after 1 year, due to "bad luck", crash: 876_000 becomes 438_000 (– dont tell me thats not possible). and it'll take the s&p 7.5 years to be at 100% again, so +9.7%p.a., i.e. +7.7%-when-adjusted-for-normal-inflation
** after 2 years ur taxable brokerage is at 31_233, so "you wont make it"; but lets put taxes aside
** after 7.5 years your trad-ira is at ~200k
** then next crash: trad-ira 120k, roth ira: (back at 52k+90k+129k) x 0.6 = 163k
doesnt look so good anymore, bc now you are broke after 6 more years
=> NOT GOOD
it's a similar "math" as you did in your "leveraged-etfs dont work"-video, i.e. it depends on the so-called "path" how things REALLY go.
of course, the scenario is (probably) too extreme, and you may assume that everything goes on like its been since 2010, but in the end, nobody knows and bad things can happen (look at the pandemic we have). you should therefore be aware that you may need a plan B or at least have "room-for-adjustment".
— real security you can only get with a pension-insurance, but starting at 40, they would only pay you ~28-32k/year when giving them
1_250_000 (their usual earnings should suffice to adjust the 28-32k for inflation from year to year, but if they are not operating on the basis of run-off-in-worst-case, they can get broke)
I'm sorry, but I honestly think the sweet spot would be converting $12K a year, where you pay 0% tax!
My understanding is that you CAN take out the money after 5 years if: you’re a first time home buyer, for medical expenses, and education (I believe). However, if I just say, “I need to live off of my conversions because I just want to retire early,” isn’t the IRS going to ask for evidence? Only because it is not an exception?
Dumb question – are you required to stop working in order to start the conversion?
Great video! In it you mention that it's not recommended to convert from a traditional 401k directly to a Roth IRA and I'm curious to know why? Are there still concerns if you're already over 59.5? Fidelity makes it sound easy to rollover from a traditional Fidelity 401k to a Fidelity Roth IRA (not a 401k Roth). Thanks!
Best explaination yet! Thanks!
You're neglecting inflation, but otherwise great video. Inflation is the one thing that sort of makes all investing seem a lot worse, or at least more complicated. Over the last century, average inflation was 2.72%. Depending on what you spend your money on, different goods and services appreciate/depreciate at different rates. Property, food, energy, etc. all have wildly different inflation rates. IMO, if you're planning a retirement, you need to account for inflation, but that doesn't change the concepts behind what your video explains. And tax brackets are unfortunately not tied to inflation, so you might actually convert the same amount for 5 years, but use a gradually increasing amount. You just probably don't want to assume if you can live with $52,000 a year that you can do so in 5 years from now. In 5 years from now, that's only $45,470. 15 years from now, your $52K is only $34,768.
And, of course, inflation, S&P market return rates, etc. are all variables that nobody knows the true future values of. Long term we can say inflation was X, and the S&P was Y. But if war breaks out between the US and China and nukes are launched, your market investments may not perform as well.
Although I also don't think bonds are much better. If anything horrific happened, people are going to default on their debt and the US Government is not immune to this. Gold is a much more stable investment. Even if we return to the stone age, people will forever think gold is valuable. Unless Elon Musk captures an asteroid made of gold and crashes the gold economy. And even then, gold will still be valuable. It's useful in electronics and industry, not to mention jewelry. It might take some time for gold to recover, but it would get there eventually.
This video deserves more views
A truly wonderful video! You did a great job explaining. Thank you!
I heard you breeze over a comment saying money rolled over from a Roth 401k to a Roth IRA can be touched in 5 years. Do [contributions] [earnings] in your Roth 401k not just turn in to [contributions] [earnings] in your Roth IRA?
Hi Jake!
This is one of the best video I have seen on YouTube, explaining very well the conversion process.
But I have a doubt!
When you pull up 52K from your Brokerage account and you convert 52k from your IRA to the Roth it is a total of 104k so your tax bracket is in a 22% after subtract 24k of the standards deduction if you are married filing jointly (my case).
I'm feeling like I'm in a little loop here because I'm not sure if my taxes calculation is well.
Please, could you confirm if my taxes calculations were done correctly, If I will end up paying taxes only in 80k?
Thank you
I would do it a little differently. If you have enough money in your brokerage account, roll over only the standard deduction amount, and then top off your income with the deduction on capital gains sales and any principal from the brokerage account. Keep rolling the minimum amount from the ira until you hit 72 years of age when you have to take your RMD.
if i need 50000 for yearly expenses for the first 5 years of doing this I'll have to pay taxes on 100000, 50000 that i regularly need and 50000 to be transferred to the roth IRA. Very little benefits in the long run.
edit: Instead I can have 2 portfolios one of post retirement(59.5 yrs age) accounts and one pre retirement(before 59.5 yrs age), pay 15% taxes flat on all my capital gains instead of even 22% on first 50000 and 24% on next 50000.
So if you have TSP is this the same concept- my contributions are Roth and then the government matches in traditional. Should we be moving the traditional TSP funds to a traditional IRA and subsequently in batches to a Roth IRA? Or is that just completely locked until 59.5 years? I’ll be 30 years in service at 56 so trying to figure how I’m paying for years until FERS kicks in/59.5 years.
Thanks!
Finally understood it, many videos posted by others are not clear. Thanks for the detail. Can you please explain Mega backdoor Roth IRA also.
If you just have a Roth IRA and max that out, can you also create a Trad IRA and then backdoor it into your Roth IRA?
Hi Jake, thank you for all the work you put into your videos, I just finished watching your 401k/Roth Ira videos. Like you, I have about the same amount in my traditional 401k and recently started thinking about converting to a Roth IRA, so this was very helpful to understand how it works.