Could I use a SEPP to bridge the ER gap?

[zolotiyeruki]

I'm 34, on track to FI at 51 (conservatively).  Right now, about 60% of our retirement savings is in Traditional IRAs and 401(k)s, 35% is in Roth IRAs, and about 5% in a traditional investment.  Most of the balance in the Roth IRAs is gains.  In other words, not a lot of our retirement savings will be traditionally available if I decide I want to ER at 51.  Unless...

I do a SEPP.  If I have $600k in my traditional IRA at that point, the amount of the SEPP (according to this calculator) would be $20-25k, depending on the interest rate used.  When I've done a back-of-the-envelope calculation of our retirement expenses, that $20-25k would be just about what I'd expect our spending to be.  It's also, conveniently, in that sweet spot of income where individual exemptions and standard deductions wipe out almost all federal income tax liability.

  Here's how I'm envisioning it working:
Age 51-60: Live off SEPP, and if needed, a little from Roth contributions and traditional investments.
Age 60+: Use Roth IRAs for living expenses, convert "max without tax" of traditional IRA to Roth each year.
Age 65(give or take): Social Security kicks in and we live high on the hog.  Right?

So, assuming our spending is about the same amount as the SEPP, would we even need a Roth ladder to bridge the gap until 59.5?  Am I missing something?

[catccc]

I think your plan works, but the SEPP just isn't as flexible as the ladder, that might be a reason to forgo the SEPP in favor of the ladder.

[Backyard Farmer]

I think that CatCCC is right. When I've looked into SEPP, it has several downsides:
(1) Inflexible; the withdrawal amount is slightly variable, but only in a relatively narrow range.
(2) Permanence; once you start, you have to keep making SEPP withdrawals, else you'll have to pay significant penalties.
(3) Limited withdrawal amount; even though you said you will only need $25-$30k (possibly leave tax benefits on the table).
(4) Tax inefficient; withdrawing $30k/yr from a $600k account (5%/year) is likely to leave you with a substantial amount still in the Trad IRA (see below). After 70, if you have remainder, you may even face RMD.

The Roth Ladder appears to be a vastly better vehicle to me - provided you can bridge the first 5-years with existing Roth or after tax monies. Since you have time, that should be easy to do; i.e., $30k/yr * 5 yrs = ~$150k >> $9k/yr for 17 yrs (if you were starting at zero, which you are not) [note: this was a very simple and dumb calc for rough estimation only].
Another very nice feature of the Roth Ladder is that you can maximize Trad-to-Roth conversion amount based on your relatively low tax bracket (roughly up to ~$60k/yr, adjusted) and drain your Traditional IRA in 10-15 years such that by the time you're eligible for SS, you have no other taxable income (since it's already been converted to a tax free Roth) [well, you'll probably have some AT money as you stated, but you may well be taxed on those sales/dividends at the capital gains rate (remember, in your relatively low marginal tax bracket)]. GoCurryCracker goes into considerable detail on this.

[curler]

The Roth Ladder appears to be a vastly better vehicle to me - provided you can bridge the first 5-years with existing Roth or after tax monies. Since you have time, that should be easy to do; i.e., $30k/yr * 5 yrs = ~$150k >> $9k/yr for 17 yrs (if you were starting at zero, which you are not) [note: this was a very simple and dumb calc for rough estimation only].

But wouldn't this money be taxed at the current high-income tax rates?  Presumably Zolo is in his high earning years so doesn't want to be taxed on the extra income at this point.  Given that, and given the lack of contributions in the Roth and taxable accounts, how is the ladder more tax efficient?

[AJ]

(2) Permanence; once you start, you have to keep making SEPP withdrawals, else you'll have to pay significant penalties.

It isn't permanent, though. It's only required until age 59.5, after which point it functions like a regular IRA again. Since the OP is planning on starting at age 51, that's only 9-ish years. A roth ladder has a 5-year "inflexibility" too in that you have to guess 5 years ahead of time what you will need. If the OP was retiring now (at age 34) the the semi-permanence of the SEPP would be a bigger deal. But retirement in one's 50's is exactly what the SEPP was created for.

[madamwitty]

Posting to subscribe.

I am seriously considering SEPP because the Roth ladder doesn't play well with FAFSA and I do plan to fund our 3 kids' college during ER. But the inflexibility of the SEPP puts me off a bit, we would be doing it for upwards of 15 years until we'd be eligible for regular withdrawals.

A couple of ideas to improve flexibility are:

Split the IRA into multiple accounts, so as to split the IRA into multiple potential SEPP streams. Take SEPP withdrawal from only one account in the early years while burning down taxable accounts, then add other stream(s) as time passes. If something happens (eg I get a side hustle and don't need the money) I don't have to pull the trigger on the 2nd or 3rd SEPP. Can use the other accounts for a Roth conversion ladder.

SEPP allows for a one-time switch from one distribution method to another. (Can't remember the details offhand).  Depending on the account balance, this may allow me to scale back withdrawals if I have a side hustle or prefer to rely more on Roth conversion ladder.

[zolotiyeruki]

Backyard Farmer raises some good points, but I think the downsides are mitigated as follow:
1) I don't anticipate our spending changing hugely from year to year. If our spending is lower, I'll convert the excess into Roth.  If spending is higher, I'll pull out of Roth/traditional
2) It's only "permanent" until 59.5 or 5 years, whichever comes later.
3) Same as #1
4) Since the SEPP is not entirely permanent (in my case, it'd only last until 59.5) I can change the withdrawals eventually, and minimize my tax burden that way.

[madamwitty]

1) I don't anticipate our spending changing hugely from year to year. If our spending is lower, I'll convert the excess into Roth.  If spending is higher, I'll pull out of Roth/traditional

Can you really do that? I was not aware that a coversion counts toward the SEPP withdrawal amount. You can't just withdraw and subsequently make a Roth contribution because IRA contributions require earned income.

[zolotiyeruki]

1) I don't anticipate our spending changing hugely from year to year. If our spending is lower, I'll convert the excess into Roth.  If spending is higher, I'll pull out of Roth/traditional

Can you really do that? I was not aware that a coversion counts toward the SEPP withdrawal amount. You can't just withdraw and subsequently make a Roth contribution because IRA contributions require earned income.

You're right--I misspoke.  So let's assume I put the excess into a traditional investment.  At our levels of spending, when I eventually withdraw those funds, we'll still (barring changes to tax law) pay no tax on those qualified dividends/capital gains, so the effect is the same.

[madamwitty]

1) I don't anticipate our spending changing hugely from year to year. If our spending is lower, I'll convert the excess into Roth.  If spending is higher, I'll pull out of Roth/traditional

Can you really do that? I was not aware that a coversion counts toward the SEPP withdrawal amount. You can't just withdraw and subsequently make a Roth contribution because IRA contributions require earned income.

You're right--I misspoke.  So let's assume I put the excess into a traditional investment.  At our levels of spending, when I eventually withdraw those funds, we'll still (barring changes to tax law) pay no tax on those qualified dividends/capital gains, so the effect is the same.

Fair enough! The distinction is important in my situation, because taxable vs IRA makes a difference for college financial aid.

[Eric]

So, assuming our spending is about the same amount as the SEPP, would we even need a Roth ladder to bridge the gap until 59.5?  Am I missing something?

Inflation?  Are you really going to be able to live off of $25K/year 15 years from now?  If inflation between now and then is 3%, your current $25K of spending is the equivalent of spending $38K in 2030.  I'm assuming that the SEPP amount will only cover $25k of that $38k that you'd want to spend.  Can you make up the difference with your Roth and Taxable?

[zolotiyeruki]

So, assuming our spending is about the same amount as the SEPP, would we even need a Roth ladder to bridge the gap until 59.5?  Am I missing something?

Inflation?  Are you really going to be able to live off of $25K/year 15 years from now?  If inflation between now and then is 3%, your current $25K of spending is the equivalent of spending $38K in 2030.  I'm assuming that the SEPP amount will only cover $25k of that $38k that you'd want to spend.  Can you make up the difference with your Roth and Taxable?

I should have mentioned that all these numbers are inflation adjusted, but yours is a good point. 

[Trudie]

I've heard it referenced here before, but can someone link to a "Roth Ladder Explanation for Dummies" for those of us who are late to the party?  I know there have been threads on it, but I need something that's spelled out a little more step by step.  Thanks.

[curler]

http://jlcollinsnh.com/2013/12/05/stocks-part-xx-early-retirement-withdrawal-strategies-and-roth-conversion-ladders-from-a-mad-fientist/