Nick, one of our readers, is starting a new job and he plans to roll over his 401k to an IRA at Vanguard. He wants to invest everything in a target-date fund because they require virtually no maintenance. He can focus on saving as much as possible without having to worry about rebalancing or timing the market. 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 over my 401k to Vanguard when I retired from my engineering career in 2012. After 7 years, I’m still happy with this decision. Passive index funds performed pretty well over that period.
Anyway, Nick has a 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 significant, it will push Nick up the tax bracket and he will pay more taxes next April.
Some Roth IRA rules
- The capital gain is tax-free once you’re 59.5 years old. This is a huge advantage especially if you start early.
- You can withdraw your contribution to the Roth IRA anytime, penalty free. However, the rule is different for the capital gain. If you are under 59.5, you will have to pay tax and a 10% penalty on any gains. 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 will 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.
You can read more here – How to start contributing to a Roth IRA.
Roth IRA conversion ladder
In my opinion, Nick should rollover his 401k to a traditional IRA and defers the tax.
You don’t want to pay tax now if you don’t have to. Once Nick retires early, then he can minimize taxes 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 obscure concept if you aren’t changing jobs or planning to retire early. Nonetheless, it is a rare gift from the IRS. Everyone should learn about the Roth IRA conversion ladder even if you are not quite ready to retire yet.
Okay, the 2 main points are:
- You pay tax at the time of conversion from 401k to Roth IRA.
- 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 pay much less tax this way than if he rollover his 401k to a Roth IRA in one shot.
Example
Let’s look at our account for example.
We have about $1.2M in our tax-deferred accounts, 401k and Traditional IRA. Our annual cost of living is around $50,000. If Mrs. RB40 retires next year as planned and I quit blogging, then we won’t have much income. Each year, we can convert $50,000 from our tax-deferred account to Roth IRA and we won’t have to pay much tax. Let’s put it in a table.
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.
I gave us a 5% raise every year on this table. The cost of living will inevitably increase. It’s already really optimistic to think our annual expense will stay at $50,000 in 5 years. Our passive income should make up for any shortfall so I’m not worried.
Also, it’s good to move some money from the tax-deferred to the tax-free bucket. You’ll have to take minimum distributions from your traditional IRA when you turn 70 and a half. We already have $1.2 million in our tax-deferred accounts. If we let it build up for 25 more years, the RMDs will be huge. It’s best to spread out your retirement savings in all 3 categories – taxable, tax-deferred, and tax-free.
Minimize Tax
The tax estimator at H&R Block shows we’ll have to pay the IRS just $739. That’s a very low tax rate for the $50,000 conversion + $20,000 from dividend income.
- Conversion (I put this in earned income) $50,000
- Dividend: $20,000
- Standard deduction
- Number of dependents: 1
Effective tax rate: 1.05%
The effective tax rate is ridiculously low at just 1.05%. Also, we won’t pay any tax on our $20,000 dividend income because we will be in the 2 lower income tax brackets.
If we convert the whole $1,200,000 in one shot, then we’d owe the IRS $387,809! That’s a 31.7% effective tax rate. That’s your own personal stock market crash right there, courtesy of the IRS. I’d like to avoid it if at all possible. We’ll be pushed up to the highest tax bracket that year. It doesn’t make sense to convert your whole 401k at once. The tax code is a lot more favorable if you convert a little every year. The Roth IRA conversion ladder is the perfect fit for early retirement.
Early Retirement Planning
Of course, there are a couple of gotchas.
The 5 years lag time
If you want to avoid the 10% early withdrawal penalty, then you need to wait 5 years before withdrawing. This is why you need some funds in your taxable account. We have about $500,000 in our taxable portfolio. That will be plenty to cover the first 5 years of early retirement. We also have some previous contributions in our Roth IRA that we could draw on. Nick probably should build up his taxable accounts before he retires or finds some other ways to generate a little income. Here are some options.
- Invest in rental real estate.
- Part-time work, consulting, freelancing, or other enjoyable work
- Real estate crowdfunding. This is a great way to generate passive income. You can invest in real estate projects across the USA and don’t have to deal with tenants. Being a landlord is a great way to build wealth, but it can be stressful sometimes. See how I’m doing with RE crowdfunding here.
- Build a dividend portfolio. I particularly like this option because of the tax synergy. You can’t beat the 0% tax on dividend income. You just need to make sure you stay in the bottom 2 tax brackets every year.
- Negotiate a separation package. (Don’t quit your job until you read this book.)
Inflation bites
The other problem is inflation. We don’t really notice inflation much from year to year, but it is a 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. I increased our conversion by 5% every year. This works for us because our tax-deferred account is pretty big. As long as your investment outperforms inflation, you will be okay.
Nick’s Roth IRA conversion
So for Nick, here are some steps that he could take to prepare for early retirement.
Now
- Rollover his old 401k to a Traditional IRA.
- Try to max out the 401k at his new job. Also, max out the 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 yearlong test drive.
Early retirement
- Rollover the latest 401k to his Traditional IRA.
- Set up the Roth IRA conversion ladder. I’m sure Vanguard can help with the partial conversion. They were always very helpful when I called.
- Nick might want to talk this through with a good tax advisor.
- 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 revisit this topic then. 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 bucket. Everyone needs to have a good tax strategy. It’s one of our biggest expenses and it’s unavoidable.
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?
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Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!
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Hello! thanks for this topic! I agree, people who retire early have the benefit of having more years to complete the conversion, which means they don’t have to covert as much each year. As you said, if you remain in a lower tax band after your conversion, you’ll benefit from reduced tax rates.
I have made multiple ROTH Conversions into the same ROTH account over the past few years. I will meet the 5 Year rule for my first conversion in about a month. I will then be allowed to withdraw both contributions and earnings ( I am 71 years old). The problem is I don’t know how to determine what portion of the account’s earnings overall are related to what my first conversion or any individual conversion I’ve made.
Look forward to your reply! Jerry
You should call your broker. If you convert them into the same account, then the broker should have all the records.
Good luck!
Does the conversion ladder work if your money is already in a Roth 401K?
You don’t need to do a conversion if the money is in Roth 401k. I should just transfer over.
Check with the company that runs your accounts.
This article was very eyeopening. Thank you! I’m considering rolling over my Traditional IRA funds over to my ROTH IRA as I’m not earning income from a W2 job right now. I do have $20-30k in rental income though but don’t make any other passive income.
Could you please breakdown how you ended up with $739 @ 1.05% paid for taxes on the Roth Conversion at an earned income of $50,000?
Does my thought process below align with how you got to this?
If the standard deduction for married is $24,400, which would decrease your earned income for the year to $25,600 as taxable income. Assuming your mortgage interest on your loans sits around $20,000/year, which would make your taxable income around $5000-7000 and put you in the <5% tax bracket.
The tax code was changed in 2018. I need to rewrite this post to reflect the new standard deduction.
You can use your tax software to help figure out the rate. Or talk to a tax accountant.
Sorry!
I loved this article thanks. Question; I am 56 retired at 54 and have a great 401k with a self manage option I use thru TD. So no need to move for flexibility. Can I forgo the Traditional IRA all together and slowly convert from my 401K to my Roth instead given I like my 401k? Thanks Gregg
I don’t see why not. Check with your 401k plan if they’ll let you do that. Usually, they like to write one big check. They might not let you convert a bit at a time.
Hi, I recently learned about the Roth conversion ladder, and I’m really excited about it. Thank you for the explanation. I was wondering how rental income plays a part in the Roth conversion. Is rental income considered earned income or passive income? I’m not sure if I can retire by 40, but I’m aiming for 45.
Rental is like a business income. I’m pretty sure it isn’t passive and is taxed at the regular rate. Please check with the IRS.
New angle: The death of a spouse would cause the widow(er) to jump into a higher tax bracket suddenly. Seems that this dreaded “widow’s penalty” would make Roth conversions much more attractive. I mean, what are the chances that both husband and wife pass in the same year? Can’t bet on that.
For the first 5 years of retirement, if you had a previously existing Roth (prior to conversion) couldn’t you live off of your contributions. tax and penalty free while you waited for the rollover money to become available? What am I missing?
Yes, you can do that. I think the problem is most people don’t have a lot of money in their Roth IRA.
Most of our retirement fund is in our 401k and Traditional IRA. So the conversion ladder serves multiple purposes.
Taking the money out of our Traditional IRA a little at time so we don’t pay a lot of taxes. Also, it will help with RMD later on.
Great idea. One caveat that probably should be emphasized is that the Roth conversion ladder only works when you have no or little earned income. So, for Nick the Roth conversion ladder would be great but only sometime in the future(after he has retired). Also if he is married and his spouse still works that would also complicate it.
The question I have about the 5 year wait period is it based on the contribution age or the account age. I have seen it multiple times in multiple ways. So in your ladder example you open an account and put the money in, could you take out the full amount you put in the first 5 years at year 6 when you take it out or can you only take out the $50k?
I have a ROTH that has an age of 20 years (1999), so I hit the 5 year date easily. So I am only asking that I can take out my contributions? Like I put in $6k for 2019, and can I take that out tomorrow since the account is over 5 years old? the IRS regs are really wonky to read and I am looking for a definitive answer.
I’m pretty sure it depends on the contribution age. It doesn’t matter how old the account is.
That’s what I’m counting on, anyway. It doesn’t make sense to base it on the age of the account. I have a Roth that’s 20 years old too.
You should check with an accountant to make sure.
This is a spot-on plan for many people. Unfortunately, it won’t work well for us. Fortunately, it’s a good thing that it won’t work for us.
My wife’s pension, along with my blogging, dog sitting, and freelance work, will likely push our income into that third level of the tax bracket. Then we have rental properties that should add a solid income in 2027 or so. I know this is a good problem to have!
We’ll have to see what we can do. There’s still some room for a conversion, but it may be difficult as we don’t know exactly what income these small businesses will bring in.
looks like a good strategy to me. i don’t mind paying a little tax now and getting money into that roth. we’ve funded two of them since ’06. i feel like this is about as low as tax rates will go and i really want those tax-free gains in 10 years or so.
Hi Joe! Excellent post and I’m with you wholeheartedly until you determine how much you can transfer without increasing your tax liability. What are the levels or tax brackets now. Maybe smaller amounts could be transferred earlier – like $5000 or $10000 without much of an impact. That stops me from starting a Roth ladder each time, and then I think I’m too stupid to be thinking about it, so I don’t do it. You’ve mentioned this before and I love the idea but I just don’t get the last step. Thanks, Joe – I’ll keep on reading anyway. I’m smart enough to know that’s a good thing. HAHA!
That’s a tough one. You need to look at it year by year.
One thing you could do is to use the tax software from last year. It should give a good estimate.
I would guess that quite a few people who retire early may also plan on taking their Social Security Retirement at age 62 years. ROTH withdrawals do not count as income against your social security while IRA withdrawals do which can result in your social security check being taxed. It is a little more complicated than that, but anything with taxes is complicated. This may not affect everyone, but it is another benefit of doing a ROTH Conversion ladder.
I would also add that if the market or just a stock you own takes a dive, you could do the conversion then and not pay taxes on the conversion until April. The tax owed would be at the price at time of conversion. I wish I had known this in 2008.
Thanks for pointing this out. I never understood the benefit of the Roth conversion until I saw your comment. BTW I’ll be taking social security @ 70,which I suspect to be a more common choice for the “retire early” crowd who tend to think longer term.
Thanks. That was clearly and simply explained with good, concrete personal examples. This is why I enjoy your blog.
Thank you! I appreciate it.
One of the best advantages for individuals that retire early is that they have more years to do the conversion and thus don’t need to covert as much each year. As you pointed out if you can stay in the lower tax brackets you can really get favorable tax rates for your conversion.
I will certainly attempt to do this myself but because I have a lot of passive income I won’t be able to convert quite as much each year (but retiring early hopefully will make that a moot point)
My blog income will get in the way too. We’ll just have to do it carefully, year by year.
Once I stop blogging, it will be a lot easier to do the conversion.
If I convert money from a 457 b account to a 457 b ROTH account and then transfer the 457 b Roth money to a traditional ROTH IRA before the 457 b ROTH account has been in existence for 5 years or more, but the ROTH IRA has been in existence for more than 5 years, mean that I can access the transferred money when I turn 59.5? I was told that it is the original ROTH that counts when it comes to the 5 year wait, not the ROTH that it was transferred from. Is that correct? Or should I just wait until I retire and convert the 457 b to a traditional IRA and convert the IRA money to a ROTH IRA at that time?
I have been funding a Roth IRA and a SEP IRA, because I am self-employed. How does this system apply to those who don’t have 401ks? And am I better off funding a traditional IRA for my personal contributions and then converting to Roth later?
From what I understand, SEP IRA is the same as traditional IRA. You can convert this to Roth later.
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?
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.
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.
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.
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.
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?
That’s right. You don’t have to make a withdrawal if you don’t need it.
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!
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.
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.
Wow, Cory! I am 45 and don’t even have the 3rd of what you have)) Well done, mate!
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?
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.
I”ll add there are lots of reason you might want to keep money in your 401k:
-401k may be more protected in the case of bankruptcy or getting sued. 401k is protected by federal law. State laws cover IRAs in these situations and may not shelter as much.
-If you ever want to do a backdoor Roth because your income is too high, you want as little money in your IRA as possible because of pro-ration (too complicated to explain in a comment.)
-If you leave your company’s employment in the year you turn 55, you can access 401k money w/o penalty. (Yes, you still pay taxes).
You’re right about the 401k. If you have a really good 401k plan, then you don’t need to convert it to an IRA.
I’ll need to research more about pro-ration. Thank you.
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.
Jim
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.
Eric
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.
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.
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.
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.
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.
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.
I thought under the new tax law you can no-longer recharacterize it?
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!
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?
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.
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.
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!
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.
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.
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.
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.
Good luck! It’s a lot of work now, but it will be worth it.
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.
It’s great to learn more about these tricks. The more you know the more options you have.
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.
Congratulation on your retirement! I hope the IRS don’t change the rule either.
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!
Rollover to a traditional IRA is a great move. It gives you a lot more control than moving it to another 401k.
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.