Author Topic: Roth Conversion Ladder Question  (Read 848 times)

frugalfoothills

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Roth Conversion Ladder Question
« on: February 19, 2018, 01:02:37 PM »
Might be a dumb question, but let's say you reach FIRE and want to take advantage of the Roth Conversion Ladder to access your retirement funds. Most everything I've read says to move your annual expenses over in a year-over-year schedule once you are in a low enough tax bracket.

Is there a limit to what you can roll over in a given year? If not, what's to stop someone from saving an entire year's worth of annual expenses somewhere like a basic bank account, use that to live on for the year, collect zero income and pay 0% income taxes, and then roll over their entire chunk of early retirement cash at once instead of spread out over multiple years? Couldn't you roll over hundreds of thousands of dollars into a Roth at 0% that way?

Mr. Green

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Re: Roth Conversion Ladder Question
« Reply #1 on: February 19, 2018, 05:03:01 PM »
Might be a dumb question, but let's say you reach FIRE and want to take advantage of the Roth Conversion Ladder to access your retirement funds. Most everything I've read says to move your annual expenses over in a year-over-year schedule once you are in a low enough tax bracket.

Is there a limit to what you can roll over in a given year? If not, what's to stop someone from saving an entire year's worth of annual expenses somewhere like a basic bank account, use that to live on for the year, collect zero income and pay 0% income taxes, and then roll over their entire chunk of early retirement cash at once instead of spread out over multiple years? Couldn't you roll over hundreds of thousands of dollars into a Roth at 0% that way?
When you rollover money from a Traditional IRA to a Roth IRA, the IRS considers that a taxable event. It is treated as income, and is taxed based on the Federal tax brackets for earned income. So you will only pay 0% tax to the extent that you get exemptions and/or deductions and/or tax credits that reduce your tax to zero. The more you roll over, the higher your income, the more tax you pay.

To complete a Roth IRA ladder you actually need 5 years of living expenses saved up because of the 5 year limit of withdrawing funds from a Roth IRA. So you'll need to live on that savings for the 5 years while you're rolling over funds to your Roth IRA in each of those years.

For example, a couple filing Married Filing Jointly will get a $24,000 standard deduction in 2018. So, provided you have no other income, they could roll over $24,000 and pay no federal tax on that. If they have a child, which allows for a $2,000 tax credit, they could rollover almost $20,000 more since the first $19,050 of income would be taxed at 10%.

Don't forget about state tax in this transition. Rolling over money to a Roth IRA is taxable at the state level as well, if you live in a state that taxes income. North Carolina has a $17,500 standard deduction in 2018 so rolling over $24,000 may be "free" at the federal level, but an NC resident would pay state tax on $6,500 of that "income."
« Last Edit: February 19, 2018, 05:11:08 PM by Mr. Green »