Author Topic: Roth Conversion Ladder Question  (Read 4526 times)

gripped

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Roth Conversion Ladder Question
« on: March 05, 2014, 07:38:19 PM »
Hey people. I was just about to confirm a contribution to my personal ira, for the purpose of a future roth conversion ladder strategy, but I'm concerned about a potential downfall (sort of) for early retirement... here goes:

My concern is that since you must wait 5 years for the money to sit in the Roth before withdrawing, won't you be "sacrificing" all interest during that 5 years to your future 59.5 y/o self? I will be retiring very early (30ish) and am not sure that I want to "sacrifice" that 5 years worth of interest when I could route the money to my taxable account and have full access at 30.

To state it differently: what is the comparison between the roth conversion ladder strategy and a regular taxable brokerage account when only taking into consideration the money available in early retirement?

I am not sure whether that was clear enough, but I'd love to hear some advice!

geekette

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Re: Roth Conversion Ladder Question
« Reply #1 on: March 05, 2014, 08:40:50 PM »
As I understand it, once you convert, you can withdraw the converted amount tax free after 5 years.  Growth must stay (or be taxed).

Convert $20k from Traditional to Roth in 2020 and pay whatever tax is due on the conversion (if your income is low enough, that could well be zero).  By 2025, it's worth, say, $25k.  You can only withdraw the original $20k tax free.

Cheddar Stacker

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Re: Roth Conversion Ladder Question
« Reply #2 on: March 05, 2014, 09:00:08 PM »
You want to build up your tax deferred accounts as much as possible so you can Retire Even Earlier.
http://www.madfientist.com/retire-even-earlier/

However, anything at all that's left over should be saved in an after tax account. This could be a regular investment account at Vanguard or a brokerage house, it could be a rental property, it could be cash or bonds, etc. You can also make contributions to a Roth IRA directly (which gets you no current tax deduction) and the principal of those contributions can be withdrawn at any time, so you don't have to wait 5 years.

All of this stuff will be your "bridge" between earning a paycheck and utilizing your Roth Ladder funds.

gripped

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Re: Roth Conversion Ladder Question
« Reply #3 on: March 05, 2014, 11:18:15 PM »
Thanks for the good explanations... I'm actually more interested in the math comparing the amount of money available for early retirement from a taxable account versus that from a roth conversion ladder (isolated from the portion that is off limits until 59.5).

Does the tax advantage of the roth conversion ladder, outweigh the additional 5 years of interest from a taxable account.

I'll just have to run a spreadsheet comparison, and of course keep in mind that the interest from the Roth is not actually lost.

Joel

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Re: Roth Conversion Ladder Question
« Reply #4 on: March 05, 2014, 11:50:08 PM »
Your investment in an IRA or taxable account would both likely have the same gains over that time period. The question to be asking is if it makes sense to defer taxes now and pay taxes at a later point (when converting to the Roth at a lower income potentially) or does it make sense to not get the tax break now, pay taxes on all dividends received immediately, and then only have to pay capital gains taxes upon retirement?

The link above spells out why deferring taxes now is almost always better for someone with high enough income during their working years to retire early.

sherr

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Re: Roth Conversion Ladder Question
« Reply #5 on: March 06, 2014, 07:46:36 AM »
I'll just have to run a spreadsheet comparison, and of course keep in mind that the interest from the Roth is not actually lost.

That last bit is the point. If you convert to a roth and then withdraw after 5 years the interest will continue to exist, you merely cannot take it out until retirement age without paying the 10% early-withdrawal penalty. If you need the extra $100 a year or whatever it is right this second then simply convert a little more and use the interest when you're 60.

All other things really are equal, so therefor it's best to use the account that has the greater tax advantages. So use a Roth, not a taxable account.

foobar

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Re: Roth Conversion Ladder Question
« Reply #6 on: March 06, 2014, 01:38:54 PM »
The OP didn't phrase his question very well but it is along the lines of:

You have 100k. Which is better
a) 100k in roth: 50k  contributions, 50k of earnings
b) 100k in taxable: 50k of cost basis, 50k of capital gains

If you in the 0% bracket , there is not tax advantage to you for the roth and you don't have to wait til 59 or do a 72(t).

The roth conversion strategy is designed to do 2 things
1) allow you to get the tax deduction on contributions and hopefully not pay income tax on they way out
2) get access to the money before 59 without having to do a 72(t)


Is there a case where you can end up with too much of your assets in retirement funds? I guess but it would be pretty hard.  Take a person that had a 1 million dollar portfolio split  800 ira/200 taxable who is sucking out 40k/yr. We will assume 6% rate of return on the tax deferred (lets assume taxable is in like tips) and 2% inflation.  In 30 years you will still have 617k in your ira (+ ~889k in the roth). Now sequencing will change that exact ratio.

In the worst case were you coming up short, start 72(t)ing  out some more money. If you need more than that, I think your in trouble financially:)

I'll just have to run a spreadsheet comparison, and of course keep in mind that the interest from the Roth is not actually lost.

That last bit is the point. If you convert to a roth and then withdraw after 5 years the interest will continue to exist, you merely cannot take it out until retirement age without paying the 10% early-withdrawal penalty. If you need the extra $100 a year or whatever it is right this second then simply convert a little more and use the interest when you're 60.

All other things really are equal, so therefor it's best to use the account that has the greater tax advantages. So use a Roth, not a taxable account.