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  • Writer's pictureMarc Primo

The Benefits of A Roth Conversion Ladder To Retirees

This is an article ‘The Benefits of A Roth Conversion Ladder To Retirees’ by Marc Primo

Most people think of retirees as senior folks living off savings they have accumulated throughout the years. For the financially woke, being a retiree can also mean living off the funds you accumulated at an earlier age while your other investments grow. This type of money knowledge makes the Roth Conversion Ladder appealing to most entrepreneurs considering early retirement.

While many of us dream of it, only a few can actually retire at a young age. Considering debt and other aspects of life we have to save for, it's a far-fetched ambition to settle for retirement before 60. However, there are loopholes we can take advantage of to at least be able to spend the retirement money we save when we need it.

The Roth Conversion Ladder is one such loophole that lets you convert money from your 401k to a traditional individual retirement account (IRA) and eventually into a Roth IRA. Doing so will allow you to withdraw the principal amount in only five years without incurring additional charges.

Let's take a closer look at how the Roth Conversion Ladder works and the issues you'll have to deal with to make it work:

The drawbacks of traditional IRA and 401k plans

The first thing to note if you are considering early retirement is that you can only withdraw your traditional IRAs and 401k savings plans when you reach the retirement age of 59 years and six months.

Of course, it is not a good idea to pass off such plans, especially if you are looking for worthwhile investment options when you reach retirement age. Plus, a traditional IRA allows the net amount you save to accumulate via compound interest from your investments without being taxed over time. The only caveat is that you can't use it until you are a few months shy from turning 60 and, from which point, it will be taxed upon withdrawal.

401k plans are also spared of pre-tax income while you contribute. However, you can withdraw the money you save before retirement with a 10% penalty. Your employer will match your pre-tax income and remain tax-free until you're a few months away from retirement.

The good thing about having these in place is that it sets you up for a Roth Conversion Ladder plan.

The Roth Conversion Ladder explained

As mentioned earlier, the Roth Conversion Ladder is a workaround for your traditional IRA and 401k plans that enables you to withdraw earlier without incurring tax or penalty fees. In other words, it spares you from having a massive 10% of your hard-earned savings being cut from the total amount you receive at your pre-retirement age.

If you have a substantial amount in net worth based on your traditional IRA and 401k plans and think you can live off your savings, then the Roth Conversion Ladder is ideal. Being able to transfer your money from such highly restrictive plans to a more flexible account allows you to retire from work early without worrying about losses.

One important thing to note is that Roth IRAs are not ideal if you are looking to supplement your income for the sake of pursuing an extravagant lifestyle beyond your means. The secret to efficiently using your retirement money is to accrue a significant amount in retirement savings from your retirement plans and budget what you need through the rest of your years if you opt for a Roth IRA during early retirement. Otherwise, you might end up not having enough money at your old age due to wanton spending when you were younger.

How to set up a Roth Conversion Ladder

If you are looking to retire at an early age via a Roth IRA, you'll need some patience and due diligence in transferring your money from one account to another.

The first thing you'll have to do is roll over your 401k account into a traditional IRA upon resigning from a job because this is the only time you are free to do this. As a 401k account holder, you are not obliged to stick with the same company to hold your initial 401k account.

Once you've rolled over your 401k into a traditional IRA, compute an ample annual amount you want to withdraw in five years, then transfer that into a Roth IRA. It might be best to transfer money equal to the income you get from your Roth investments while working instead of your total annual expenses, and doing so will spare you lesser taxes.

The 'Five-year Rule' finally comes when you wait for the same amount of time until you can withdraw what you've invested. After all, most financial investments require the patience of a job to reap the rewards.

When to start a Roth IRA

A Roth Conversion Ladder plan should start in the first year of your early retirement. The conversions from plan to plan will then take effect annually, with the total amount you'll need per year leading up to when you reach 55.

The reason for the five-year allowance before the standard retirement age is to limit your financial gap during the first five years of your early retirement. Once you turn 60, you can finally use all your money from your standard retirement accounts.

Another way to do a Roth Conversion Ladder is to use it after the standard retirement age of 60. However, prepare yourself for some tax cuts that will be lower than the 10% penalty fee if you choose to take out your money from your 401k account earlier. Another thing to note is that you won't enjoy any tax-free growth when you transfer money from your 401k into your traditional IRAs.

The main advantage of using the Roth Conversion Ladder is to enjoy early retirement without the usual 10% fee each time you withdraw. In many ways, this can help you be more financially independent without worrying about money in both your middle and senior years.


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