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Want to retire early? A Roth IRA conversion ladder could help you tap your tax-sheltered retirement accounts before age 59½—without the usual 10% penalty. With a Roth conversion ladder, you shift money from a tax-deferred retirement account—such as a traditional IRA or 401(k)—into a Roth IRA. But unlike a standard Roth IRA conversion, you do it multiple times over several years. If done correctly, you can withdraw the converted funds with no tax or penalty long before your 59th birthday.   

Key Takeaways

  • A Roth IRA conversion ladder is a multiyear strategy that allows you to tap your retirement account without penalty before reaching age 59½.
  • When you do a Roth IRA conversion, you must wait five years to withdraw the converted amount to avoid a 10% tax hit.
  • There’s a separate five-year waiting period for each conversion; by doing a conversion every year for several years, you create a “ladder.”
  • You should start a Roth conversion ladder at least five years before you’ll need the money.

Roth IRA Basics

A few key distinctions set Roth IRAs apart from other tax-deferred retirement accounts:

  • Roth IRA contributions are not tax-deductible (i.e., there’s no upfront tax break).
  • You can withdraw your contributions (but not earnings) at any time with no tax or penalty. That’s because you make contributions with after-tax dollars, so you’ve already paid taxes on that money.
  • Withdrawals of earnings are tax-free and penalty-free if you’re age 59½ or older and it’s been at least five years since you first contributed to a Roth account (the “five-year rule”).

That final point (the tax-free nature of withdrawals) is why Roth IRAs—and Roth IRA conversions—have become so popular.

You may be able to withdraw your Roth IRA earnings early without a penalty if you qualify for an exception, such as to pay for a first-time home purchase, education expenses, or health insurance premiums while you’re unemployed.

Roth IRA Contribution and Income Limits

Though tax-free withdrawals are a significant perk, Roth IRAs have low contribution limits, which can make growing a sizable nest egg tricky. For the 2021 and 2022 tax years, you can contribute a total of up to $6,000 to your IRA accounts. There’s an extra $1,000 “catch-up” contribution if you’re age 50 or older.

To contribute to a Roth IRA, you must have “earned income” that equals or exceeds your contribution. There are also income limits, meaning your maximum Roth IRA contribution could be reduced to $0, depending on your modified adjusted gross income (MAGI) and filing status. To contribute the full amount in 2021, your MAGI had to be less than $125,000 if single or $198,000 if married and filing jointly. For 2022, these figures rise to $129,000 and $204,000, respectively.

Investors who earn too much money to contribute directly to a Roth may still be able to fund a Roth IRA using the Backdoor Roth IRA strategy.

Roth IRA Conversions

There’s a way to get around the Roth IRA’s low contribution limits while taking advantage of the tax-free growth and withdrawals: the Roth IRA conversion. This is where you move money from one of your other tax-advantaged retirement accounts—for example, traditional IRA, 401(k), or 403(b)—into a Roth IRA. Though the most you can contribute to a Roth IRA is $6,000 ($7,000 if you’re age 50 or older), there’s no limit on Roth IRA conversions.

The most significant upside of doing a Roth IRA conversion is getting the tax-free withdrawals in retirement. This can be especially beneficial if you expect to be in a higher tax bracket when you retire—versus the one you’re in now.

Of course, the downside is that a conversion is a taxable event: You will owe ordinary income tax (but not an early withdrawal penalty) on the amount you transfer into the Roth. And it could be significant, particularly if the extra income pushes you into a higher tax bracket. As a result, investors often do Roth IRA conversions over several years.

The Five-Year Waiting Period

As noted, you can withdraw your Roth IRA contributions at any time without taxes or penalties. That’s true even if you haven’t reached your 59th birthday, or if it’s been fewer than five years since you first contributed to a Roth account—or both.

Roth IRA conversions work differently. There’s a five-year waiting period for each conversion—meaning that each conversion stands on its own. If you withdraw the converted amount before the five-year waiting period is up, the IRS will hit you with a 10% early withdrawal penalty (but no tax because you already paid ordinary income tax when you converted the funds). However, if you wait five years after each conversion, you can withdraw the money without tax or penalty. That’s where the Roth IRA conversion ladder comes in.

Roth IRA Conversion Ladders

You can create a series of tax-free and penalty-free withdrawals by “laddering” your Roth IRA conversions—that is, doing multiple Roth IRA conversions over several years.

Here’s an example. Say you want to retire at 45, and you anticipate needing $50,000 a year to live comfortably. Because you have to wait five years to withdraw each converted amount, you start building your ladder at age 40 by doing a Roth IRA conversion for $50,000.

The following year, you do another Roth IRA conversion for $50,000, and so on until you reach age 54. At that point, the series of conversions you already did will cover you through age 59½. That’s when you can start taking penalty-free withdrawals from your other retirement accounts and tax- and penalty-free withdrawals from your Roth IRA (if you still have a balance).

Note that this strategy requires you to have $250,000 in retirement savings to convert. The same technique can be employed using lower amounts, of course—or higher ones. Ideally, you would plan early in retirement to have saved enough in your tax-advantaged retirement accounts to create a conversion ladder that will yield what you need.

The following table illustrates how a Roth IRA conversion ladder might work:

What Is the Full Retirement Age for Getting Social Security?

You’re entitled to full benefits when you reach your “full retirement age,” which is age 67, if you were born in 1960 or later. You can start collecting benefits as early as age 62. However, if you start receiving benefits early, they will be permanently reduced based on the number of months you receive benefits before reaching your full retirement age. For example, a $1,000 monthly retirement benefit will be reduced to $700 if you start collecting benefits at age 62. If you delay benefits until age 70, your benefit will be the highest because you’ll receive delayed retirement credits.

When Should I Start a Roth Conversion Ladder?

If done correctly, a Roth IRA conversion ladder enables you to take tax-free and penalty-free withdrawals from your IRA before you reach age 59½. However, the converted amount must be held in the IRA for at least five years to avoid a 10% penalty. So, you should plan on starting a Roth conversion ladder at least five years before you’ll need the money.

What’s the Difference Between a Roth Conversion Ladder and a Backdoor Roth?

A Roth conversion ladder is a multiyear strategy designed to give you tax-free and penalty-free IRA withdrawals before you reach the standard age (59 ½) for distributions. To create the ladder, you convert a portion of your taxable retirement account (e.g., a traditional IRA) each year into a Roth IRA—and avoid taking one big tax hit in the process. The staggered conversions create the “ladder.” Conversely, a Backdoor Roth is a way to fund a Roth IRA if your income exceeds the limits for contributing to a Roth.

The Bottom Line

It’s never a good idea to convert all your retirement accounts into a Roth IRA and then burn through the funds before you reach 59½. After all, you can’t even start collecting Social Security benefits before age 62 (and that’s at the reduced amount), and most pensions don’t kick in until age 65.

Remember that a Roth IRA conversion ladder is intended to provide a tax-free and penalty-free income source during early retirement. You need to keep enough money elsewhere to last throughout your entire retirement—not just during those early years.