How to Resign Early With the Roth IRA Conversion Ladder

How to Resign Early With the Roth IRA Conversion Ladder

If you’re planning on retiring early, one of your biggest concerns is probably how you’ll be able to survive the retirement years before you turn 59 1/2. Like most people, most of your savings and investments may be in a tax-protected retirement plan. Of course, you also have to pay an initial 10% withdrawal penalty if you hit the account.

This can make early retirement withdrawal taxes expensive, and may even cause you to rethink the whole idea of ​​retiring early.

But rest assured that there is a solution to this dilemma. Known as the Roth Conversion Ladder, it will allow you to withdraw your retirement funds early without having to pay tax penalties – or even any taxes.

The Roth Conversion Ladder Benefit: Tapping into Early Retirement Without Paying Penalties

There are general rules about making withdrawals from any type of retirement plan. You will have to pay a 10% penalty on most early withdrawals before you turn 59 1/2. But a Roth IRA offers a solution.

Source: Current Roth IRA Income and Contribution Limits

Conversions made to a Roth IRA can be withdrawn both tax-free and free of the 10% early withdrawal penalty, as long as they are not retrieved until five years after the conversion has been made (since the tax is paid on the conversion).

The IRS said the following on the topic:

“ Distribution of certain conversions and rollover contributions over a 5-year period. If in a 5 year period starting with the first day of your tax year in which you convert amounts from a traditional IRA or rollover amounts from an eligible retirement plan to a Roth IRA, you take distributions from a Roth IRA, you may have to pay an additional 10% tax for initial distribution. You generally have to pay an additional 10% tax on any amount attributable to the portion of the converted or rolled over amount (conversion or rollover contribution) that you must include in your income (recovered amount). A separate 5 year period applies to each conversion and rollover. 

You can use this loophole to access your Roth account at any time before you convert 59 1/2, but only after 5 years have passed since the conversion was made. So if you’re 45, and you want to retire at 50, you can start making Roth IRA conversions now. If you make your first conversion at the age of 45, you will be able to withdraw an amount of $50, free of tax consequences.

Note that this only applies to your conversion balance, and not to investment income earned in your Roth account.

How to Set Up a Roth. Conversion Ladder

This strategy is referred to as the “ladder”. This is because you will want to set it up so that it covers all the years between your retirement date and when you change 59 1/2. So if you plan to retire at 50, you will need to complete 10 annual conversions. This will allow you to withdraw tax-free funds between the ages of 50 and 59 1/2.

The first step in setting up the ladder is determining how much money you will need to live on after you retire. You must then make a Roth IRA annual conversion that matches that amount.

So, if you believe that you will need $40,000 annually to retire, that will be your conversion amount this year. You will then want to perform an annual conversion to match each year of early retirement. Ideally, if you plan to retire at 50, you should start making these annual conversions every year starting at age 40.

You should also make sure that all of your retirement assets will not be exhausted by using the stairs. The ladder should only represent a temporary source of funding until you reach age 59 1/2 and can start accessing your full retirement savings. This strategy is specifically designed to allow early retirement, but should not leave you at a later date.

Roth Conversion Ladder Example

Since the Roth conversion ladder is essentially a mathematical equation, let’s show you what it looks like using a chart. We’ll assume you’re 45 and plan to retire early at 50. We’ll also assume that you expect to need $40,000 per year for early retirement.

Based on those numbers, here’s what your Roth conversion ladder should look like:

Roth Conversion Ladder Table

Year Your age Total Roth Conversion Number of Roth Withdrawals Source Withdrawn Funds
2016 45 40,000 0 N/A
2017 46 40,000 0 N/A
2018 47 40,000 0 N/A
2019 48 40,000 0 N/A
2020 49 40,000 0 N/A
2021 50 40,000 40,000 2016 Conversions
2022 51 40,000 40,000 2017 Conversions
2023 52 40,000 40,000 2018 Conversions
2024 53 40,000 40,000 2019 Conversions
2025 54 40,000 40,000 2020 Conversions


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