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Build A Roth IRA Conversion Ladder to Minimize Taxes in Early Retirement


Build a Roth IRA Ladder to Minimize TaxNick, one of our readers, is starting a new job and he is planning to roll over his 401k to an IRA at Vanguard. He is thinking about putting everything in Vanguard’s target date fund because they require virtually no maintenance. He can just concentrate on saving as much as possible without having to worry about rebalacing or timing the market. I think this is a great idea. Nick can always reallocate his investment later if he wants to invest in other funds. As for me, I rolled my 401k over to Etrade in 2012 to get a $1,000 bonus and then transfer it to Vanguard a couple of years later. 

Here is his question.

Would it be better to rollover a 401k to a Traditional IRA or Roth IRA if your goal is to retire early?

Roth IRA 

The great thing about the Roth IRA is that you won’t have to pay any tax when you take distribution from the account (once you’re over 59 and a half.) The bad thing about rolling over the 401k to a Roth IRA is that you will have to pay tax at the time of conversion. If the amount in the 401k is large, then it will push Nick up the tax bracket and he could be paying a lot of taxes next April.

Some Roth IRA rules

  • You can withdraw your contribution to the Roth IRA anytime tax and penalty free. However, if you are under 59.5, you will have to pay tax and a 10% penalty on the earning. There are some exceptions, but generally you’ll have to pay the penalty.
  • When you make a conversion or open a new Roth IRA, you will have to wait 5 years before withdrawal to avoid the 10% penalty.  
  • You don’t have to take RMDs, required minimum distributions. With the 401k, you would have to withdraw the minimal required amount once you are 70.5 years old.
  • You can pass your Roth IRA on to your kids. They won’t have to pay tax on this account.

Roth IRA conversion ladder

If Nick plans to retire early, then it’s best to rollover his 401k to a traditional IRA and defer the tax. You don’t want to pay tax now if you don’t have to. Once Nick retires early, then he can minimize tax by building a Roth IRA conversion ladder.

I hope I didn’t lose too many readers up to this point. The Roth IRA conversion is a pretty boring topic if you aren’t changing jobs or planning to retire soon. It’s a great gift from the IRS, though. Everyone should learn about this even if you are not quite ready to retire.

Okay, so the 2 main points are:  

  1. You pay tax at the time of conversion from 401k to Roth IRA.
  2. You have to wait 5 years to avoid the 10% penalty on the earnings.

The beauty of the Roth IRA conversion ladder is that it is perfect for early retirees. When you retire, your income will drop and you will be in a lower tax bracket. Nick can figure out how much money he needs to fund his lifestyle and convert that amount every year. He will most likely pay much less tax this way than if he rollover his 401k to a Roth IRA and pay all the tax in one shot.  

Let’s look at our account for example.

We have about $800,000 in our tax deferred accounts, 401k and Traditional IRA. Our annual cost of living is around $50,000. If Mrs. RB40 retires and I quit blogging next year, then we won’t have much income at all. We can convert $50,000 from our traditional IRA to Roth IRA and we won’t have to pay much tax. Let’s put it in a table.

Roth IRA conversion ladder

*I borrowed this table format from Justin’s Roth IRA ladder article at Root of Good.

Basically, you move one year worth of expenses from your 401k to your Roth IRA every year. After 5 years, you can withdraw from the Roth IRA penalty free.

Minimize Tax

The tax estimator at TurboTax shows we’ll have to pay the IRS about $1,500. That’s a very low tax rate for the $50,000 conversion. For completeness sake, I added $10,000 income from our dividend portfolio. I also deducted $6,000 for child care expense, $10,000 for mortgage interest, and $5,000 for property tax.

  • Total Income  $60,000
  • Total Deductions  $15,000
  • Total Exemptions  $12,000
  • Taxable Income  $33,000
  • Regular Taxes  $2,531
  • Alt. Minimum Tax  $0
  • Additional Taxes  $0
  • Tax Credits  $1,000
  • Tax Payments  $0
  • Your Refund  $-1,531
  • Marginal Tax Rate  15%

You can see that the effective tax rate is ridiculously low at just 2.5%. Also, we won’t pay any tax on our $10,000 dividend income because we will be in the 15% income tax bracket.

If we convert the whole $800,000 in one shot, then we’d owe the IRS $262,066! We’d also be pushed up to the highest tax bracket that year. That’s your own personal stock market crash right there. So you can see that it doesn’t make sense to convert your whole 401k at once if it’s a large amount.

Early Retirement Planning

Of course, there are a couple of gotchas here.

The 5 years lag time

If you want to avoid the 10% penalty, then you need to wait 5 years before withdrawing. This is why you need some fund in your taxable account. We have about $300,000 in our dividend portfolio and that should be plenty to cover the first 5 years of early retirement. We also have some previous contribution in our Roth IRA that we could draw on. Nick probably should build up his taxable accounts before he retires or find some other ways to generate a little income.

  • Invest in rental real estate.
  • Part time work, freelancing, or other enjoyable jobs.
  • P2P lending, P2P investing, and other ways to generate passive income.
  • Negotiate a separation package. (Don’t quite your job until you read this book.)
  • Build a dividend portfolio. I particularly like this option because of the tax synergy. You can’t beat the 0% tax on dividend. I just hope the tax law stays the same.

Inflation bites

The other problem is inflation. We don’t really notice inflation much from year to year, but it is a pretty big problem when there is a 5 year lag time. We spend about $50,000 per year, but we need to add inflation if we’re planning for 5 years down the line. At 3% annual inflation rate, we’d need 16% more in 5 years. That means we will have to convert about $58,000 assuming we keep our spending at about the same level. We need to fix the table and take inflation into account.

Roth IRA conversion ladder inflation

Wow, inflation looks pretty scary. As long as your investment outperforms inflation, you probably will be okay.

Nick’s Roth IRA conversion

So for Nick, here are some steps that he could take to prepare for early retirement.  


  • Rollover his old 401k to a Traditional IRA.
  • Keep funding the new 401k and Roth IRA.
  • Slowly build up his taxable accounts

3 years before early retirement

  • Figure out his retirement budget. Estimate how much money he’d need to spend after retirement by tracking his expenses
  • Figure out how to pay for the first 5 years of early retirement. He probably should try to boost his taxable account at this point.

1 year before early retirement

  • Build up his cash position.
  • Take his retirement budget for a year long test drive.

Early retirement

  • Rollover the latest 401k to his Traditional IRA.
  • Set up the conversion. I’m sure Vanguard can help with the partial conversion. They were always very helpful when I called.
  • Don’t forget about inflation.
  • You might want to talk this through with a good tax adviser. 
  • Enjoy early retirement!

If you need help with tracking your expenses and net worth, then check out Personal Capital. They have a great site that will help you figure out your early retirement.

RB40’s Roth IRA conversion plan

For us, it doesn’t make sense to do any conversion at this point. Mrs. RB40 is still working and our household income is not low enough. Mrs. RB40 plans to retire in 2020 and we will have to revisit this topic in a few years. Even if you don’t plan to retire early, this is useful information because you might have some years with low income. You can make some conversion on those low income years and move some money to the tax free bin.

That’s it. I hope this is helpful for Nick. Do you any advice for him?

If you retired early, how did you access your tax deferred account?

If you need help keeping track of your finances, try using Personal Capital to manage your portfolio. Also check out their fantastic retirement calculator. You can read my review here –The Best Free Retirement Calculator.

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Joe started Retire by 40 in 2010 to figure out how to retire early. He spent 16 years working in computer design and enjoyed the technical work immensely. However, he hated the corporate BS. He left his engineering career behind to become a stay-at-home dad/blogger at 38. At Retire by 40, Joe focuses on financial independence, early retirement, investing, saving, and passive income.

For 2018, Joe plans to diversify his passive income by investing in US heartland real estate through RealtyShares. He has 3 rental units in Portland and he believes the local market is getting overpriced.

Joe highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help every investor analyze their portfolio and plan for retirement.

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{ 38 comments… add one }
  • Steve Miller September 7, 2015, 5:07 am

    Great advice for Nick. We did exactly what you mentioned (converted the IRA to a Roth) in year 2 of my retirement, once our income had decreased because were simply living off of dividends and capital gains from our investments.

  • Ali @ Anything You Want September 7, 2015, 5:38 am

    This is super helpful! I’m in the process of changing jobs now and am trying to figure out where to put my retirement savings from my previous job. I’m planning to do a rollover IRA, but a Roth conversion may be in my future too!

    • retirebyforty September 7, 2015, 9:09 am

      Rollover to a traditional IRA is a great move. It gives you a lot more control than moving it to another 401k.

  • Lorraine September 7, 2015, 6:27 am

    We have just recently retired and can’t wait to start implementing the ladder conversion strategy. Obviously, we can’t do much this year without going into a higher tax bracket, but next year, look out! We are so looking forward to it. Just hope the IRS doesn’t change the rules.

    • retirebyforty September 7, 2015, 9:10 am

      Congratulation on your retirement! I hope the IRS don’t change the rule either.

  • Kristi September 7, 2015, 6:50 am

    This is a topic I don’t have any experience with, so I appreciate you laying this out. I love learning new ways to manage my retirement accounts.

    • retirebyforty September 7, 2015, 9:11 am

      It’s great to learn more about these tricks. The more you know the more options you have.

  • Mrs. Budgets @MrandMrsBudgets September 7, 2015, 6:52 am

    We plan on doing a roth conversion ladder down the road when we both retire. Were in the process of building up our taxable investments to get us through the first 5 years.

    • retirebyforty September 7, 2015, 9:11 am

      Good luck! It’s a lot of work now, but it will be worth it.

  • Pennypincher September 7, 2015, 7:22 am

    Perfect timing on this subject, Joe. I just finished reading Vanguard’s Roth IRA Conversion Kit yesterday!
    It is a lot of info. It is not easy to absorb either. It can be complicated, but everyone should learn about it.
    The window of opportunity to convert is when your income tax bracket is at it’s lowest, because you will be taxed for that conversion IF the traditional IRA you are converting was a non-deductable IRA. See, starting to get complicated.
    Vanguard states in it’s booklet- A Roth IRA can provide important advantages, it also has significant consequences.
    I say, talk to your tax advisor, read up as much as you can (this can take time, and it’s not exactly exciting reading, ha ha). Talk to your financial advisor. Take notes! Go to Vanguard’s website and/or talk to them-great service. I always like to learn as much as I can before I talk to them. It’s somewhat complicated, and you certainly don’t want to be bumped up to the next tax bracket, but I believe it’s worth it.
    The last money you should withdraw from your retirement account would be the tax free (Roth IRA) $$. Hope this helps.

    • retirebyforty September 7, 2015, 9:15 am

      Thanks for your comment. I forgot to add – talk to your tax advisor at the end.
      Vanguard customer service is really good. They are so helpful whenever I’ve called.

  • Justin @ Root of Good September 7, 2015, 9:10 am

    This is pretty much our exact plan (and thanks for the link back to my own Roth conversion ladder article!).

    What’s often missed is the funding for the first five years while you’re setting up the conversion ladder. We’re sitting on at least 10 years worth of living expenses in a taxable account so we won’t have to worry about tapping the Roth IRAs we’re converting to for at least a decade.

  • Kevin September 7, 2015, 10:26 am

    Great article! I am in my early 20’s and just starting to plan for early retirement. Would it be better for me to invest in a Traditional IRA and do a Roth IRA conversion ahead of retirement, or simply invest in a Roth IRA from the beginning?

    • Justin williams September 8, 2015, 4:32 am

      First get your employer match if there is one. Then fund your Roth, then your employer plan, then your taxable account to maximize the benefits of each. Also put your dividend payers in the Roth.

      • retirebyforty September 8, 2015, 10:45 am

        That’s the way to go.
        Alternatively, if you want to keep it simple. You can just try to max out your 401k first and then Roth IRA. That’s just fine too. It’s simpler.

        • Kevin September 9, 2015, 9:07 am

          My employer offers a SEP IRA plan and does not require any match funds. My question was aimed more at Roth vs Traditional IRA for my personal contributions separate from my work SEP IRA (with early retirement in mind). But I think both of you mentioning Roth IRA answered that for me. Thanks!

  • maarten September 7, 2015, 2:58 pm

    I am retired early (at 44) and do have a gap between my taxable account and the time I can withdraw from my 401(k). My taxable account will run dry 5 years prior to the age I can withdraw (penalty free) from my 401(k). I am very tempted by all of what is stated above but I have the following reservations (that I may just have to overcome).

    -First off all I read a lot of articles about this conversion by individuals that actually plan on using it. Not so much from individuals that have actually done it.
    -What many don’t seem to mention is that when you convert your 401(k) to an IRA there is the potential of loosing a lot of protections that come with a 401(k). with 401(k)’s you are protected in case of lawsuit and/or bankruptcy. IRA protection is dependent on the state you live in and might not be protected at all. One should look into that.
    -All of this sounds like a loophole, and I do worry like one of the other commenters on whether this loophole will stay in place. 5 years is a long time to work all this out. Laws can change in this time.
    All of that said the logic seems sound. I might talk to a tax adviser on this.

    btw, I think the article explained the IRA conversion ladder very well. Thank you for that.

    • steve September 7, 2015, 9:10 pm

      I’ve been doing the roth conversion ladder for almost 10 years now. One of the great loopholes about a roth conversion that wasn’t mentioned in the article is that although you have to do the conversion by the end of calendar year, you have until your taxes need to be filed (potentially october of the following year if you file the extension) to recharacterize (essentially undo) part or all of the conversion. For example, you could convert $50K by december 31st, then play around with “what-ifs” while doing your taxes and recharacterize any or all of the $50k to maximize tax efficiency.

      For those of us in ER trying to hit the right thresholds for ACA benefits recharacterization is also a great way to “fine tune” your income at tax time.

    • retirebyforty September 8, 2015, 10:41 am

      Hi Maarten,
      – Some of the readers are doing this according to the comments. I think Justin at Root of Good is also building a Roth IRA ladder.
      Yes, the extra protection is nice if you keep it in your 401k.
      – I guess if your 401k plan is really good, then you should stick with it. I already converted my 401k to traditional IRA. I didn’t want to keep my investment with my old employer’s plan.
      – Right. I hope the law doesn’t change here, but who knows. You have a long lead time so I don’t see any downside to converting some money to Roth IRA. I doubt they will change the tax free aspect of the Roth. They might close the loop on the conversion, but that’s all the more reason to do it now.
      Good luck!

  • Bryan @ Just One More Year September 7, 2015, 5:33 pm

    I liked the conversion ladder concept and once we retire, we will convert some of our retirement funds through that process.

    A couple other strategies to consider are the 72t rule that allows one to draw funds that have been invested for over 5 years without penalties. (I believe you were alluding to that) It requires us to follow certain minimum distribution amounts and you still have to pay income tax. One could use this strategy for funds from one past employer if you have accumulated multiple retirement accounts over the years.

    It does seem to me that based on the example of the conversion; your affective tax rate will be much lower using that approach since the Roth can continue to compound tax-free once converted.

    • retirebyforty September 8, 2015, 10:42 am

      Yes, the 72t rule is another great option if your 401k is really big. I didn’t want to throw that concept into the same article.

  • freebird September 7, 2015, 8:09 pm

    That’s one of the downsides of staying on the payroll instead of retiring early (or becoming a highly-paid blogger), it shrinks your ladder so you have to convert more during each low-income year meaning you will likely owe more in taxes. There probably comes a point when it’s too late to convert and you’re better off paying the taxes on your RMDs.

    On the other hand if the balance is small, your tax bracket isn’t that high, and you have many years before RMD time, I think it could be worthwhile to pay the taxes associated with a Roth conversion immediately even while working. The possibility of tax-free appreciation for many years on an after-tax contribution may still be appealing, especially if you think growth rates will improve and/or tax rates will rise in the future. Knowing what I now know, if I had access to a Roth 401k where I started work, I would have selected this option from the beginning.

  • Retire29 September 8, 2015, 8:08 am

    Great article and effective strategy. I wrote (http://www.retire29.com/withdraw-your-retirement-accounts-in-your-30s-no-taxes-no-penalties/) about how we’re implementing this Roth conversion strategy to avoid paying penalties and nearly all taxes on our tax-deferred assets. The rule of 25x your yearly expenses can be slightly modified to “You still need 25x your expenses, but only 5x needs to be in taxable accounts.” It ended up being my most popular post to-date.

    Thanks for posting and drawing more attention to this tax strategy.


    • retirebyforty September 8, 2015, 10:50 am

      Nice article. I don’t necessarily agree with trying to move most of your portfolio to a taxable account. Even if you don’t plan on selling, you will probably sell at some point. The dividend income would be nice, though.

  • jim February 5, 2016, 12:25 pm

    I just noticed this : ” I also deducted $6,000 for child care expense”

    I am pretty sure you can’t deduct child care unless you’re both working. And in that example it doesn’t seem either of you would work.


  • natphoru May 24, 2017, 9:35 am

    One thing I think is missing is why you might want to do this to begin with. The initial question being answered was “which is better, Roth or Trad IRA”. But, I don’t see anything answering why I wouldn’t just keep my money in a 401(k). This is an actual question I have. Maybe another article topic? At present, I’m saving to various pre and post tax accounts. I know I won’t have access to some of the pre-tax accounts until I hit 59 1/2, and I have that account for in my early retirement plan. Is there a reason I would want to convert instead of just waiting until I get to 59 1/2?

    • retirebyforty May 25, 2017, 6:52 am

      You should have both type of accounts. They will give you more tax option when it’s time to withdraw. You might want to convert early if you have a ton of money in your pre-tax account. You can convert and stay in the low tax brackets. It’s a good way to build up some fund outside of the pre-tax account. You never know when you’re going to need it.

  • Cory May 25, 2017, 7:24 am

    Hi there! Must say, I love the blog – I’ve read most of your posts by now!

    I’ve only recently discovered the roth IRA ladder, but it seems that it’s definitely the way to go – it’s just a matter of timing.

    1) Is there any good reason NOT to do the ladder conversion at some point in one’s lifetime? It seems that moving to a Roth IRA (with no RMD, no taxes for heirs) is a no brainer(?).

    2) I’m 38 years old and currently have
    ~175k in an orphaned 401k
    ~30k in Roth IRA
    ~550k in taxable accounts

    I’m not sure when exactly I’ll begin the conversion process to Roth IRA’s – given that a large majority of my assets are in taxable accounts, it makes more sense to keep what I can in non-taxable accounts.

    But is there any good reason to hold off on moving my orphaned 401k to a traditional IRA now? (The fees and options in both my 401k and Vanguard are actually comparable, so that’s not really part of the equation for me.)

    Would love to hear your thoughts!

    • retirebyforty May 25, 2017, 9:55 am

      1. If you’re in the high tax bracket your whole life, then it might not make sense to do a conversion. You’ll just pay more taxes. Most people don’t have that problem, though.
      2. I think it’s great that you have a large amount in the taxable account. It’ll give you a lot of flexibility with early retirement.
      I’m all for moving your 401k to a traditional IRA. You’ll have more investment choices and more control. Unless your 401k is already really great, there is no reason to hold off. The 401k has stronger protection against lawsuits. I think that’s the only thing at your age.

      • eyeonFI June 2, 2018, 7:54 am

        One reason to not roll your 401k into an IRA is that you can beef up your Roth IRA using the backdoor method if you are ineligible to make Roth IRA contributions due to high income. To use the backdoor method and not pay any unintended taxes, you must not have any pre-tax dollars in an IRA. You add post-tax dollars to an IRA (in 2018 that’s up to $5500 for you) and then immediately (before it earns anything) do a conversion of those dollars to your Roth IRA.

    • David @ VapeHabitat July 26, 2018, 10:41 am

      Wow, Cory! I am 45 and don’t even have the 3rd of what you have)) Well done, mate!

  • Ryan June 30, 2017, 12:24 pm

    Question – you are not required to make the withdrawal from the Roth after 5 years, right? Can you leave the amount you converted in the Roth and let it grow?

    • retirebyforty June 30, 2017, 8:28 pm

      That’s right. You don’t have to make a withdrawal if you don’t need it.

  • Olli April 28, 2018, 12:42 am

    Great article!
    I have a question on the “Minimize Tax” section in the article:
    In that tax year you convert the first $50,000, you only list $10,000 dividend income in addition to the $50,000 Roth conversion. Since you can’t use the Roth conversion in that tax year for income, you have to drastically lower your standard of living for that year down to $10,000 in order to only pay $1,500 in federal taxes.
    Or supplement with selling equities from taxable account but pay higher taxes.

    • retirebyforty April 28, 2018, 8:56 am

      That first year, you’d have to supplement it somehow. The easiest would be selling equities from taxable account. You shouldn’t have to pay that much tax because it won’t be all gains, right? The capital gain tax is 15% so it’s not that bad.
      Part time work would be a good option too.

  • FinancialDave June 14, 2018, 12:18 pm

    It is a shame that this information on Roth IRA conversions has cost a lot of people spendable income in retirement, because whenever you do a conversion at a higher tax rate — say 15% for all the people doing this in 2015, 2016, & 2017 and before – they could now have been spending the money from their IRA @ a 12% tax rate. I have published many articles on this subject showing the math behind the fact that most people with less than a $100k retirement income need, waste money by putting too much into the Roth. This article is a typical example of how that happens. Once you are in retirement, in most cases your tax rate has already gone down, so conversions don’t help you and worrying about the RMD is usually not an issue for most with less than $2 Million in their IRA. Just spend it down at those lower tax rates and be happy.

  • Gabe September 5, 2018, 6:37 am

    I’ve been reading a lot about the Roth conversion ladder as I’ve begun planning for my own early retirement. I understand that in order to execute this, the old 401K should be rolled over into a traditional IRA and then eventually converted to Roth.

    One thing that is not clear to me though is why the advice is to fund a Roth vs. Traditional? Is it so there is access to some funds during the 5 year wait time? Or is there some other benefit that I’m missing?

    • retirebyforty September 5, 2018, 8:31 am

      Roth is good because you’ll be able to withdraw the contributions without having to pay the 10% early withdrawal penalty. This is the easiest way to access your retirement fund and avoid the penalty. You can’t do that with traditional IRA.

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