ROTH IRA Conversion Ladder - YouTube

Hey, this is Brad Barron.

I'm the co-founder and co-host of the choose of vibe podcast.

And want to talk to you about one of the most interesting

things in personal finance?

It's the Roth IRA conversion ladder.

Now this is something that a lot of us had never heard about, but

it really can be life-changing.

So who is this good for?

This is good for anybody who has saved a significant amount of money.

In a tax deferred retirement vehicle.

So that's a fancy way of saying your 401k, for instance, for most of us,

that's where we've stocked away.

Most of our retirement funds, right.

We have a regular job.

We put money in each paycheck into our 401k, and we're saying, okay, someday.

Maybe after 59 and a half, which is this bizarre time that we're

allowed to take withdrawals from that penalty free at 59 and a half.

I can get this money, but what do I do if I want to retire before then?

I think that's where the Roth IRA.

I think that's where the Roth IRA conversion ladder really can

come in, especially for those of us looking to early retire.

So here's what you have to do.

Basically, what we're ultimately trying to do here is to take this

money, this big pot of money that we have sitting in a 401k and get it

out of there into a Roth IRA, which unlike a traditional IRA or 401k,

which is tax deferred with a Roth IRA, it's actually, it grows tax-free

forever and you can take the money out and withdrawals tax-free as well.

Okay.

So now what we're ultimately doing is we're creating a conversion.

So we are trying to pull some money out.

Of our 401k.

We're basically saying, Hey government, I want you to tax us on

this money and I'm going to put it then into the Roth IRA, and then it's

going to grow tax-free forever and I can pull it out tax free as well.

So, okay.

That doesn't sound all that interesting, right?

Because you're going to have to pay tax on it, but here's

where the magic comes in.

So ultimately you want to do this when you're at a very, very, very low.

Taxable income point.

Okay.

So for instance, let's say your income from your job is zero, right?

You've early retired and you have $0 of income.

Okay.

Now let's say your yearly expenses cost you about $40,000, which is

not, not unreasonable for someone who's maybe paid off their mortgage

and has reached early retirement.

So.

You know, okay.

I've got to cover $40,000 a year.

So what's interesting is you can pull out and convert

$40,000 from your 401k.

And that again, that's taxable.

At that point, but you're putting it on a tax return with $0 of income.

So now your income is 40,000, but you get deductions, right?

The government gives you a standard deduction at the very, very least,

which for in 2021, for those filing married filing joint, it's $25,100.

And that actually goes up.

Every single year, it's kind of index for inflation basically, but

let's say worst case, it stays there.

So you have your 40,000 and then you get to deduct,

just reduce that by 25,100.

So you have $14,900 of taxable income.

And at that income level, your federal tax rate is only 10%.

So you're only paying $1,490 in tax on that $40,000 that

you took out of your 401k.

And now remember the beauty of this is you put that money into your

401k at your highest income level when you were making a lot of money.

And you were putting this money into your 401k for someday, right?

For retirement.

So you got this huge tax deduction in value, and now to take it

out, if you take it out at this opportune time, you're only

paying this tiny, tiny percent.

That's $1,490 on $40,000.

That's a little more than 3%, which is just unheard of.

So basically you're doing that every single year.

So that's where.

This ladder comes in.

So, you know, you need to cover $40,000.

So every single year you're going to convert $40,000.

And again, it's going to cost you somewhere in the vicinity of

$1,500 in tax, which is nothing.

That's a pittance.

So the perfect scenario who this is absolutely perfect for is those people

who have reached early retirement.

They have some money in their regular investing accounts.

To cover their first five years of living expenses.

So that's the other tiny little wrinkle with us is that when you make

a conversion, a Roth IRA conversion, you're allowed to pull this money out

tax and penalty free after five years.

Okay.

So that first conversion you made of $40,000 on day one, five years later,

you can pull that money out that converted money out tax and penalty

free, which is a fancy way of saying.

You can grab that money and use it.

So that will cover five years down the road.

And then every subsequent year you made that conversion.

So therefore you can pull another $40,000 out and

you see the magic of this.

You can pull all of your money out, ultimately from your

401k and get it basically.

Tax-free or pretty darn close.

So I guess that that last little wrinkle is just having enough

money saved up to cover your first five years of expenses.

So if you can do that from your normal savings, your normal

investment accounts that aren't inside of an IRA or 401k, then

this entire Roth IRA conversion ladder can work just magically.

So yeah, I hope that was a good overview and gives you a sense

of just how powerful this can be.