How a Roth Conversion Ladder Can Save Future Taxes and Release Retirement Funds Sooner – NBC Los Angeles

How a Roth Conversion Ladder Can Save Future Taxes and Release Retirement Funds Sooner – NBC Los Angeles

  • A Roth conversion ladder is a multi-year strategy to roll over tax-free funds into a Roth IRA to stimulate future tax-free growth.
  • You pay an upfront levy on the converted balance, but after five years there is no 10% penalty for early withdrawal.
  • However, if you use the conversions after only five years, you run the risk of no longer being able to achieve tax-free growth in the future.
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Converting Roth IRAs is a popular way to reduce future taxes on tax-free withdrawals from 401(k)s or IRAs. Experts say you can limit your tax burden up front with a “Roth conversion ladder.”

Roth conversions move pretax or nondeductible IRA money into a Roth IRA, which provides future tax-free growth. The tradeoff is the regular income tax that will be levied on the converted balance that year.

For comparison, a Roth conversion ladder is a series of conversions over several years, meaning “you pay taxes in smaller increments,” according to a certified financial planner Preston Cherryfounder and president of Concurrent Financial Planning in Green Bay, Wisconsin.

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Roth conversion ladders are a “strategic and tactical approach” that takes into account years of tax projections, including future withdrawals, according to Ashton Lawrence, CFP and principal at Mariner Wealth Advisors in Greenville, South Carolina.

For example, instead of converting $200,000 from pretax to Roth in one year, you could spread that out over several years, depending on your income. Of course, increasing your adjusted gross income in a given year could have other tax implications, such as the elimination of certain tax benefits.

“It’s not a one-time planning assignment,” because you have to review the planned renovations every year and adjust them where necessary, Lawrence said.

‘Unlock’ your pension funds sooner

One of the key benefits of the conversion ladder, which is similar to regular Roth conversions, is the tax-free “compound growth of future gains,” said Cherry, who is a member of CNBC’s Financial Advisor Council.

But the strategy is also popular among people who retire early and want to tap into their pension fund before age 59 and a half without penalty, he said.

While you can access your Roth IRA contributions at any time, there is typically a 10% penalty for early withdrawal of earnings before age 59½, with some exceptions.

However, you can use Roth conversions without the 10% penalty or taxes after five years to “free up some of your money sooner,” Cherry says. But each conversion has a separate 5-year period.

There is also a 5-year hold period for Roth IRA accounts. This rule means the account must be open for at least five years to avoid taxes or penalties, even after age 59½.

While it may be attractive for people under age 59½ who retire early to withdraw their converted IRA balance after five years, you will be giving up future tax-free growth, Lawrence says.

Typically, it’s more advantageous to do Roth conversions when there’s more time for compound growth. Plus, you want to make sure you break even on the prepaid taxes before you touch the account, he said.