How to Retire Early With a Roth IRA Conversion Ladder

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If you are planning on early retirement, one of your biggest concerns is probably how you will be able to survive in the retirement years before you turn 59 1/2. Like most people, the vast majority of your savings and investments are probably in tax-sheltered retirement plans. Of course, you will also have to pay the 10% early withdrawal penalty should you tap those accounts.

This can make the tax cost of early retirement withdrawals prohibitive, and might even cause you to rethink the whole idea of early retirement.

But rest assured that there is a solution to this dilemma. Known as the Roth conversion ladder, it will enable you to withdraw retirement funds early without having to pay the penalty tax -- or even any tax at all.

The Roth Conversion Ladder Benefit: Tapping Retirement Early Without Paying a Penalty

There is a general rule on 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 the Roth IRA offers a workaround.

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Conversions made to a Roth IRA can be withdrawn both tax-free and free of the 10% early withdrawal penalty, as long as they are not taken until five years after the conversion has been made (since the tax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

The IRS says the following on the topic:

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

You can use this loophole to access your Roth accounts anytime before you turn 59 1/2, but only after 5 years have passed since the conversion was made. So if you are 45 years old, and you want to retire at 50, you could begin making Roth IRA conversions now. If you make the first conversion at age 45, you will be able to withdraw that amount of money at 50, free from tax consequences.

Remember that this applies only to your conversion balances, and not to the investment income earned in your Roth account.

How to Set Up a Roth Conversion Ladder

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

The first step in setting up the ladder is to determine how much money you will need to live on once you retire. You will then have to make annual Roth IRA conversions that match that amount.

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

You should also make sure that all of your retirement assets won’t be depleted as a result of using the ladder. The ladder should only represent an interim funding source until you reach age 59 1/2 and can begin accessing your retirement savings fully. The strategy is designed specifically to enable early-retirement, but should never leave you broke later on.

An Example of a Roth Conversion Ladder

Since the Roth conversion ladder is essentially a math equation, let's demonstrate what it looks like using a chart. We'll assume that you are 45 years old, and plan to early retire by 50. Well also assume that you expect to need $40,000 per year in early retirement.

Based on those numbers, here's what your Roth conversion ladder will look like:

YearYour AgeAmount of Roth ConversionAmount of Roth WithdrawalSource of Withdrawn Funds
20215040,00040,0002016 Conversion
20225140,00040,0002017 Conversion
20235240,00040,0002018 Conversion
20245340,00040,0002019 Conversion
20255440,00040,0002020 Conversion

The Tax Implications of Creating a Roth IRA Conversion Ladder

When constructing a Roth conversion ladder, you need to be fully aware of the tax implications of what you are doing. In each year involving a conversion, you'll have to pay ordinary income tax on the amount converted. That means that if you are converting $40,000 per year, and you are in the 28% tax bracket, you will pay $11,200 in taxes each year.

That's a heavy price to pay. Keep in mind that you will be doing it for the purpose of providing yourself with a tax-free source of early retirement income. That is, you are trading a tax liability now, for an income source that will enable you to retire early without a tax liability.

From a tax standpoint, it would be more beneficial to wait to begin the conversions until you actually retire. If you can do that, then you will be in a lower income tax bracket. As a result, the tax cost of the conversions will be much lower. For example, if the same $40,000 annual conversion were done when you were in the 15% tax bracket during retirement, the tax cost would be just $6,000 per year. However, for some people, this would eliminate the possibility of early retirement. It’s really a matter of your goals.

How to Minimize Income Taxes on the Roth Conversions, Too

There’s an even better tax strategy if you are able to do it. Live on non-tax-sheltered savings and investments for the first five years that you are working the Roth conversion ladder.

Why five years? Remember that the rule is you must wait at least five years after making the Roth conversion in order to withdraw the converted funds tax-free and penalty-free. If you can live on non-retirement assets during those five years, you can make the Roth conversions with minimal tax consequences, since you will essentially have no other taxable income.

Considering that a standard deduction and two personal exemptions get you an immediate $20,000+ in non-taxable income, you would only have to pay tax on $20,000 of the $40,000 Roth conversion. That would mean your tax liability would be only slightly higher than $2,000.

After five years have passed, you can begin withdrawing your conversion balances from your Roth IRA account each and every year until you turn 59 -- without having to pay any taxes or penalties on the amounts withdrawn.

So, if you have been planning for early retirement, but you’ve been spooked over how to access retirement funds without being clobbered by taxes and penalties, the Roth IRA conversion ladder could be the solution to your problem. And remember, consult a tax specialist before making any decisions as the consequences of making a mistake can be costly.

Where to Open a Roth IRA

Your options for a Roth IRA account are vast. A few of our favorites here at Dough Roller are:

You can also see our comprehensive list of IRA brokers here, along with more options and information.

What do you think about the concept of a Roth ladder? Do you intend to implement something like this in your own retirement plan?

Kevin Mercadante

Kevin Mercadante

Since 2009, Kevin Mercadante has been sharing his journey from a washed-up mortgage loan officer emerging from the Financial Meltdown as a contract/self-employed slash worker accountant/blogger/freelance blog writer on

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