What Is a Roth IRA Conversion Ladder?

For many of us, there is no greater dream than being able to retire early. Spending time with your loved ones. Pursuing your passions without having to worry about clocking in and earning a paycheck. Enjoying the legacy you’ve built.

Determining whether you’re able to retire early requires some careful decision making. If you’re planning to use retirement accounts—like a traditional 401K, 403b or IRA—you could be subject to taxes and early withdrawal penalties that could significantly eat into your nest egg.

However, this isn’t true of the savings held in all retirement accounts. Contributions made to a Roth IRA can be withdrawn penalty- and tax-free almost immediately, making them an ideal savings vehicle for someone thinking about early retirement.

If you were late adding a Roth IRA to your retirement plan but still want to retire early, you could build a Roth IRA conversion ladder to take advantage of these perks.

Below, we discuss how a Roth conversion ladder works and how it can help give you access to your savings before you reach retirement age.

How Roth IRAs work

A Roth IRA is an individual retirement account (i.e., it is not sponsored by an employer) that you fund with after-tax money. That means that you pay taxes on any contributions you make in the year that you make those contributions. Then, when you withdraw money from the account during retirement, those withdrawals are tax-free.

Here are a few things to know about Roth IRAs:

Roth IRA’s have contribution limits

There is a limit to how much you can contribute to a Roth IRA each year. In 2024, you can only contribute $7,000 to a Roth IRA per year ($8,000 if you’re over 50). This is significantly less than the contribution limits for 401(k)s and other employer-sponsored retirement accounts.

How much you can contribute to a Roth IRA depends on your income

Whether or not you can contribute to a Roth IRA depends on how much money you make each year. In 2024:

• Single filers making less than $146,000 can contribute the full amount ($230,000 if you’re married filing jointly).

• Single filers making between $146,001 and $160,999 ($230,001 - $239,999 if you’re married filing jointly) can contribute a reduced amount, depending on their income.

• Single filers making $161,000 or more (those who are married filing jointly making $240,000 or more) can no longer contribute to a Roth at all.

Roth IRA contributions can be taken out penalty- and tax-free—but earnings work a little differently

Because you make contributions to your Roth IRA with after-tax money, you can withdraw those contributions at any time without paying a penalty or taxes—even before you hit retirement age at 59 ½. The rules for withdrawing Roth IRA earnings, however, are a bit different.

Early withdrawal of earnings could result in a 10 percent penalty and you’d have to pay tax on the withdrawal. Generally, once you reach 59 ½ and your IRA has been open for at least 5 years, you can take withdrawals of both contributions and earnings without worrying about penalties and fees. There are some exceptions to the 10 percent penalty when taking an early distribution of earnings, though, depending on what you’re using the money for.

How Roth conversions work

A Roth conversion is the process of converting the money held in a traditional retirement account, such as a 401(k) or IRA, into a Roth IRA. The conversion requires you to pay income taxes on the funds you convert in the year that you convert them, but as noted above, those contributions will then grow tax-free from that point on.

People pursue a Roth conversion for several reasons:

• There are no income limits for conversions: While there are income limits for contributing directly to a Roth IRA, there are no such income limits for conversions. A Roth conversion can therefore be a viable path toward contributing to an after-tax retirement account even when your earnings are too high.

• There is no limit to how much you can convert: Though you’re limited to a $7,000 cap on making direct contributions to a Roth IRA, there is no limit to how much you can roll over into a Roth IRA through a Roth conversion.

• You can withdraw funds earlier: By converting the money held in a traditional retirement account into a Roth IRA, you may be able to access your contributions early—penalty-free. Being able to access those savings early means you can have a source of income during early retirement, giving you an option to delay accessing other benefits like Social Security or the money held in a traditional account.

But there’s a caveat: When you contribute funds directly to a Roth IRA, you can withdraw those contributions at almost any time without penalty. With a Roth conversion, however, you’ll need to wait five years before you can withdraw the converted funds penalty-free.

Building a Roth conversion ladder can help you meet these requirements while also managing your tax impact during the year you make your conversions.

What is a Roth IRA conversion ladder?

A Roth IRA conversion ladder is a savings strategy where you make several smaller Roth IRA conversions over several years.

If you convert all your funds in one year, you could bump yourself into a higher tax bracket, requiring you to pay higher taxes—and potentially negating the tax benefits of the conversion to begin with. But by making several smaller conversions, you break up the taxes on your conversations into smaller pieces.

As long as you start building your ladder at least five years before you plan to retire, you’ll have funds that you can withdraw without penalty to support you during early retirement.

How do you run a Roth conversion ladder?

Let’s say that you’re 45 and want to retire at age 50. And let’s say you believe you’ll need $60,000 per year of after-tax income from your retirement account to support yourself.

To build a Roth IRA conversion ladder capable of supporting this income stream, you would complete your first Roth conversion in the year of your 45th birthday. You can then withdraw these contributions without penalty when you are 50.

Of course, you don’t just need income in the year you turn 50. You’ll need income in each year of your early retirement. So, you continue building your ladder by making a $60,000 Roth conversion each year until your 55th birthday.

This means that for the first five years, you are making a $60,000 conversion each year and taking no withdrawals from your Roth IRA. For the next five years, you are making a $60,000 conversion and taking a $60,000 withdrawal each year. For the final five years, you are making no conversions, but taking a $60,000 withdrawal each year.

Once you reach 59½, you no longer need a conversion ladder to access your retirement savings. This is why you can stop making conversions after you turn 55.

Of course, as noted above, this strategy requires you to plan carefully so you don’t accidentally push yourself into a higher tax bracket in any given year. If such large conversions would push you into a higher tax bracket, you may want to look for a way to make smaller conversions—either by starting sooner or by supplementing with other sources of income.

Pros and cons of Roth conversion laddering

Pros of a Roth conversion ladder

The primary benefit of building a Roth IRA conversion ladder is that it allows you to build a tax-free income stream that can be accessed before you reach age 59½, making it ideal if you want to pursue early retirement. Another key benefit lies is that making multiple smaller conversions (vs. one larger lump sum conversion) can help you avoid jumping into a higher income tax bracket, which could remove some of the benefits of a Roth conversion to begin with.

Contribution limits that apply to Roth contributions do not apply to Roth conversions, which means you may be able to put more money into a Roth by converting funds than you would otherwise be able to. And because income limits do not apply to conversions, building a Roth conversion ladder can be a great way of saving in a Roth when you otherwise may not be eligible to do so.

Cons of a Roth conversion ladder

To build a Roth conversion ladder capable of supporting you through early retirement, two things need to be true. First, you need enough money saved in a traditional retirement account to fund the conversions. Second, because of the five-year waiting period, you’ll need the foresight to start building your ladder well in advance of when you’ll actually need it.

If you don’t plan ahead, a Roth conversion could also push you into a higher tax bracket in the year that the conversion takes place, which can have a significant tax impact.

Is a Roth conversion ladder worth it?

Like with any retirement savings method, you’ll want to understand how a Roth account will work with other parts of your retirement plan. The best retirement plans rely on a variety of financial options—not just one account. You may very well also plan to use 401(k), a pension, Social Security or an annuity in retirement. So, while a Roth conversion ladder could help you retire early, you’ll want to understand how it will impact your retirement plan as a whole.

Planning ahead is the name of the game when it comes to saving for retirement. Working with a financial advisor to help you plan can help ensure you’re getting the most out of your savings. Your financial advisor will ask questions to better understand what type of retirement you want, then they’ll help you design a retirement plan that meets those goals. Along the way, they’ll show you which financial options best fit your situation and give you recommendations on how and when to contribute to or access those options—and make adjustments as needed—to stay on track with your goals.

This publication is not intended as legal or tax advice. Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation.

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