Roth IRA Conversion Laddering

It’s possible to annually extract ~$10k of money from (non-Roth) Traditional IRA/401k retirement plans, during early retirement, in a tax and penalty-free way.

Early retirement requires increasing financial assets and decreasing costs. One method of decreasing costs is reducing taxes. Contributing to Traditional IRAs and 401ks while you are employed will reduce taxes. However, you must wait until age 59.5 before accessing the money without penalties.

A Roth IRA Conversion Ladder can help you extract $10k out per year from tax-deferred retirement accounts, during your early retirement. This strategy works because of the following:

  • Each calendar year, you can take ~$6.5k standard deduction and ~$3.5k personal exemption, for a total of $10k of below the line deductions. Note that this amount adjusts for inflation each year and increases over time.

  • You can convert tax-deferred retirement accounts into a Roth IRA by declaring the amounts converted as income in the year the conversion takes place.

  • You can convert whatever portion of the account into a Roth that you desire.

  • Roth IRAs can have their principal contributions taken out without penalty, at any time, as long as the account has been open for at least five years.

  • When you do a paid conversion of tax-deferred accounts into a Roth, then the conversion will become a “principal contribution” to that Roth IRA after a period of five years.

Those are the requirements for this plan to work and as of this post in the year 2017, they are valid. Here is the general strategy:

January 1, 2018. You are 40 years old and retired. You have a Roth IRA balance of $200k and a 401k of $500k
You perform a conversion of $10k worth of 401k into the Roth IRA. The balances are now:

  • Roth: $210k
  • 401k: $490k

You have incurred a tax liability for this $10k of income, but due to standard deduction and personal exemption, you owe $0 in taxes.

You withdraw $10k from the Roth IRA. Your balances are now:

  • Taxable: $10k
  • Roth IRA: $200k
  • 401k: $490k

The $10k you withdrew from the Roth IRA is an old principal contribution you made years ago as you were building it. There is no penalty and no tax on this withdrawal. Thus, you took $10k out of the 401k, tax and penalty-free in the year 2018.

Repeat for 5 years. You’ve now taken $50k over the course of 5 years from the 401k. At this point in time, it’s the year 2023. Your original 2018 Roth IRA conversion is now 5 years old and has become a principal contribution. Thus, that $10k is eligible to be removed tax and penalty free.

This strategy works as long as you have at least ~$50k in Roth IRA contributions prior to starting the ladder. It will take 5 years before your first conversion becomes seasoned into being considered a principal contribution. And once you hit that point, you can infinitely take out the $10k from the conversion 5 years prior.

$10k a year isn’t enough to live on for most people, but if you’re retiring early, you likely also have some taxable


I believe this is after a Trad IRA to ROTH conversion only though? I thought that principal contributions to a ROTH, beginning as a ROTH, could be withdrawn penalty free at any time.

1 Like

It is a lesser known rule, because most people who contribute to Roth IRAs will do so at a young age and will easily get to the 5-year mark before taking any withdrawals.

According to IRS Publication 590b, page 30 of the 2016 edition:

"What Are Qualified Distributions?
A qualified distribution is any payment or distribution from your Roth IRA that meets the following requirements.

  1. It is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your benefit, and
  2. The payment or distribution is:
    a. Made on or after the date you reach age 591 2,
    b. Made because you are disabled (defined earlier),
    c. Made to a beneficiary or to your estate after your death, or
    d. One that meets the requirements listed under First home under Exceptions in chapter 1 (up to a $10,000 lifetime limit)."

And also worth noting, just because a Roth distributoin isnt “qualified” doesn’t mean it is necessarily taxable. There are ordering rules and when you’re taking out principle, which comes out before earnings, you aren’t taxed and the penalties for being young, are figured as a multiple of the tax (hence also zero).


The $10k taxable income from a conversion would be subject to tax. You can’t use the personal exemption and standard deduction to say this transaction doesn’t have a tax effect, you would have to use the marginal rate. Very unlikely someone would be in a position to retire at 40 with those figures and have no other income through retirement.

1 Like

Income is fungible. If the only income you have is $10k from a conversion, then the standard deduction and personal exemption does apply. It may be unlikely someone can retire at 40 without other income, but it’s definitely possible. And with interest rates at 1%, even if you’re paying taxes on $100k of savings, you’re paying taxes on $1k of income, so only $9k would be tax-free Roth conversions in that case.

That’s fair then, but in that scenario, you should be converting $10k (or $9k) without thought (without thought as to tax consequences anyway). The fact that you’re taking distributions from your IRA is irrelevant.

Therefore, the 5 year rule doesn’t really come into play in your example. Contributions come out before conversions. So the with $50k in contributions, that already 5 years of conversions (because you should be doing them anyway with no other taxable income).

1 Like

Correct. Even if you don’t want to take any distributions from the retirement accounts, it’s prudent to do a Roth IRA conversion, tax-free, up to the amount you can each year, to make full use of the standard deduction/personal exemption.

Regarding the 5-year rule, it does come into play, because suppose you had $0 in a Roth IRA and $300k in a 401k. You cannot, in year 1, convert $10k of 401k into a Roth tax-free and then take a $10k distribution from the Roth. That $10k needs to sit in the Roth for 5 years.

Example 2: Suppose you had $10k in a Roth IRA that’s been in there for >5 years. You have $300k worth of 401k and start doing the conversions, $10k per year. After year one, you’ve taken out the only seasoned money in the Roth IRA, and the remaining $10k will require another 4 years to season.

There’s two separate 5 year rules and that might be causing some confusion:

  1. The Roth IRA needs to be open for 5 years before you can take out principal contributions without penalty
  2. Any converted money needs to sit in the Roth IRA for 5 years before it seasons into being considered a principal contribution

Thus, in my original post, I mention needing ~$50k in your Roth IRA to start with, because once you retire and start the Conversion Ladder, you cannot tough any of the conversion ladder money for 5 years. So if your goal is to take out $10k per year, then you need 5 years worth of withdrawals already in the Roth IRA to cover you until that initial conversion becomes seasoned. From that point forward, you’ll ladder the withdrawals so that you are taking out the money exactly 5 years after it was converted.

I think this is wrong - isn’t that 5 year rule only for no penalties on earnings? Principle should be tax and penalty free without a waiting period.


I thought there was a special 5 year rule for conversions, to keep you from converting and then immediately withdrawing the “principal” as an end-run around the rules.

Good thread. I’ve basically been following this strategy- living off taxable savings, miles/points/etc. and doing Roth conversions up to the lower brackets / ACA subsidy maximum. I’ll be able to withdraw tax-free once I get into the ladder a few years from now,


The benefit you’re gaining is the ability to withdraw penalty free. You aren’t really withdrawing tax free. If, in that year you converted, you instead decided to just withdraw the funds from the taxable account, the only difference in that year is that you’d have to pay the early withdrawal penalty.

It’s tax free because once the 401k gets converted into the Roth and five years seasoning has past, it’s considered a principal contribution and you can take it out tax-free.

Technically, you have to pay “tax” when you did the conversion, but if you’re under the $10k std deduction/pers exemption limit then you didn’t pay any tax on the conversion.

The end result is being able to take out $10k per year tax and penalty free from the 401k.

1 Like

Right, I understand the mechanics, and I understand what you’re saying. Assuming your other income is constant from year to year (i.e. in this example, 0, but the amount doesn’t really matter for my assertion), and no state tax differences in these scenarios, you’re only saving the early withdrawal penalties. Not that it’s not worthwhile to avoid those penalties, but you still aren’t saving on taxes on the income.

Scenario 1
Take an early distribution of 10k
Income tax on the 10k: $0 (based on standard deduction, personal exemption)
Penalty on the 10k: $1k
Total amount due: $1k

Scenario 2
Convert 10k from 401k to Roth IRA and wait 5 years to withdraw
Income tax on the 10k: $0 (based on standard deduction, personal exemption)
Penalty on the 10k: $0
Total amount due: $0

Difference between scenario 1 and scenario 2: $1k (which is the penalty amount in scenario 1)

ETA: As a side note - it doesn’t technically become a principal contribution after 5 years. If it is a qualified rollover contribution, it’s one from day one. The five year period doesn’t change that. All the five year period language changes is the applicability of the 10% penalty to distributions of qualified rollover contributions. In almost all circumstances this is irrelevant, but there could be situations in which it could matter -such as converting one year, then making the first vanilla contribution to a Roth the next year - both 5 year periods you refer to above would begin with the year of conversion.


Regarding the penalty: you could skip the conversion altogether if you were fine with paying the penalty. Just withdraw $10k from your 401k. Done.


When do I get to hit this pot of gold totally tax free? 59 1/2?

Yes, but another major benefit of the Roth is no Required Minimum Distributions (RMDs) that apply to 401ks. This allows you to keep the money in the Roth as long as you like, earning tax-free profits as you go. Also lets you hand it down to your children in a better manner.

I secretly hope we have the cure for death in the next 30 years, at which point the US Government bans all new Roth IRAs, since they will be too good, potentially allowing tax-free earnings forever, but grandfather in all the existing account holders.

Then I can be the envy of all the young whippersnappers, much like people today with Old Blue Cash 5% AMEX grocery cards and people with iBonds that have a 3% base rate.

1 Like

It’s enough to make me want to lever it slightly just to amplify the tax-free returns. Definitely want to hold stocks in the Roth instead of trad ira, right?

A pro trader like a certain someone we know could crush it trading in a Roth with reliable low-vol returns.

1 Like

No difference - internal tax rate is the same for any retirement account, i.e. zero. You just want to hold things that go up :).

Separately, the decision to convert or not is based on future vs present tax rates, and if you’re being careful, the tax drag on the funds you use to pay taxes on the conversion in the two scenarios. But that has almost nothing to do with the investments inside (except for the tax drag on the side taxable account in the careful case).

1 Like

Oooohhhh, oooooohhhh. Me!!! Me!!!


There is some potential to increase returns by asset allocation between accounts.

Hypothetically, say you only have a traditional IRA and a Roth IRA (no taxable accounts and everything in a 401(k) has already been moved to one of those IRAs. In that scenario, all gains in the traditional IRA are taxable (when withdrawn), all gains in the Roth IRA are still tax free. With asset allocation, I would put the safer (lower return) investments into the traditional IRA and the riskier (ideally higher return) investments in the Roth IRA.

1 Like