Roth Conversion Ladder Strategy

Roth conversions are the process of transferring money from tax-deferred accounts, such as 401ks or IRAs, to tax-free accounts like Roth 401ks or Roth IRAs. When you move money from one account to the other, you generally pay taxes on the full amount converted. The money then grows tax-free from there on out.  

It is common to max out 401ks and IRAs during years of higher income and then withdraw or do Roth conversions during years of low income, perhaps in the early years of retirement or between jobs. One strategy to consider is to implement small Roth conversions, a little at a time, over multiple years.

For this strategy, there are several key time periods that I like to focus on during retirement.  

Retirement age until 72 – You are don’t have to take Required Minimum Distributions from retirement accounts yet.  

Ages 62 to 70 – You can generally begin collecting Social Security anytime between these periods. Since Social Security adds to your taxable income, your taxes should play a factor in when you claim benefits.  

In the example below, a couple is retiring in 2021, and the bars represent their total income for each year of retirement. Each source of income is a different color, with the yellow representing the amount converted to a Roth IRA.

Behind the bars, you will see 3 separate lines. Let’s call the purple bar their “high” tax bracket, the green line their “middle,” and the blue line their “low.”  

As you can see, during the early years of retirement, they implement a Roth conversion ladder strategy, converting up to, but not over their “high” tax bracket. Then, later in retirement, once larger required minimum distributions kick in, they stop doing Roth conversions.  

This results in their income hovering around but not going substantially over their “middle” tax bracket for the rest of their lives.  This might help them substantially lower their total lifetime taxes paid and also take advantage of other benefits like lower Medicare premiums, or in 2020, qualifying for stimulus payments.

This strategy is not for everyone. I see it most beneficial for those retiring before age 70 with some assets outside of pre-tax retirement accounts. As always, talk with your tax and financial advisor before implementing.  

Thank you for reading, 

 Alex 

This blog post is not advice. Please read disclaimers.