Roth Conversion Ladder Explained

how's it going everybody this is beat

the bush today I'm gonna talk about the

Roth conversion bladder and what the

heck is it

why do you need it now Roth conversion

ladder is basically a very interesting

thing for someone looking to retire

early so in the fire community financial

independent retire early community

people are interested in amassing a lot

of net worth and then retire officially

retire which means that you do not earn

any money and somehow before the

retirement age they want to access the

capital inside their 401k or IRA so

sometimes people call this a roth

backdoor what this basically allows you

to do is convert money in your

retirement accounts which is pre-tax and

then put this in your Roth IRA wait five

years and then you can withdraw it

without paying the 10% penalty now a lot

of times people would call this Roth

conversion bladder penalty free tax free

now this tax-free almost seems like you

can just some house make money away from

your pre-tax money and then somehow take

it out without paying any taxes all the

way through this is not true when they

say penalty free is well it's penalty

free after you wait five years when they

see tax free it's tax free when you take

money out of it but not when you

actually put it in when you do this Roth

conversion it basically relies on the

fact that you are not working you're

actually retired you're not doing any

work at all and then you have amass all

this wealth and you're just trying to

figure out the best way to spend it so

what someone that is retiring early is

trying to do is access that 401k or IRA

capital without paying a penalty so what

you're really doing is trying to

withdraw this 401k or IRA money at a

minimal tax rate so when you do this

conversion you're actually still paying

an income tax hit on this what is

interesting here is that if you are

really not working at all

you might be able to withdraw so little

that the standard deduction of twelve

thousand two hundred dollars or if

you're married a bit more this may

actually completely cover your

conversion amount therefore you're

paying zero dollars in taxes so I've

created this example 401k Roth and Roth

gains and how much cash you would have

for a tip

call engineer I would say at the age of

34 you might have saved a million

dollars maybe if you worked a lot try to

ignore how much this person actually has

an at what age because it's gonna be

different for everybody it might be that

you're 50 years old and you finally

reach a million dollars in your 401k but

just take this as a concept where I'm

just trying to describe how this Roth

conversion ladder really works so at the

age of 34 let's say you almost have a

million dollars in your 401k you got

$40,000 in your Roth contributions let's

say and I'm just gonna say no gains

you're really probably gonna have some

kind of gains in there and then you have

a hundred sixty thousand dollars of cash

this is just the beginning at the age of

35 you finally reach 1 million dollars

and at age 35 you decided oh I am going

to retire you stopped working completely

at this age if your burn rate let's say

it's $40,000 you're gonna go through

this $200,000 in about five years now

this is the perfect amount and this is

on purpose

because this works out perfectly for the

Roth conversion ladder I want to

illustrate what happens if you don't

have enough cash but you have plenty of

money in your 401k but you want to

access this cash in your 401k before

your retirement age and you don't want

to pay any penalties but you see if you

try to take 40 thousand dollars out of

your 401k you have to pay taxes on it

but I'm just gonna assume you made a

little bit more gains in your 401k so it

just works out perfectly maybe you would

true like $45,000 $48,000 and you pay

taxes on this and then after taxes you

still have $40,000 exactly and you put

that in your Roth so really in your 401k

you gained fifty thousand dollars let's

say due to market gains that's why it's

staying the same it's 1 million 1

million 1 million so you made just

enough to put forty thousand dollars of

active after-tax money in your Roth and

then you go on and do it for the next

year the next year the next year the

next year and then you can see your cash

over here it goes from 200 thousand 160

because you need $40,000 to live on and

then it goes to 120 80 40 and then

finally on your fifth year you have zero

cash now this is not an ideal case

because you probably want some cash

to do something sometimes you have

emergencies or something but I just want

to illustrate that how you can quickly

drain your cash if you don't work at all

and you're taking $40,000 out every

single year your Roth gains over here I

put this separately because you cannot

really withdrawal this until you are 59

and a half so during this five year

conversion ladder process you can see

your Roth is increasing by $40,000 every

single year and then right on the fifth

year you take out $40,000 to live on

because you don't have any cash anymore

and then that year you're still taking

$50,000 out of your 401k putting into

your Roth you're paying the taxes here

but at the same time that you're putting

in this $40,000 you're also taking out

that $40,000 that you contributed over

here five years ago that's why you can

take it out without this ten percent

penalty and then the year after that you

do the same thing you're still also sort

of draining your 401k but not really

because of market gains it stays at 1

million dollars and then that same year

you're taking $40,000 out so through

this ladder ink an keep on living even

though you have zero cash you can still

use $40,000 every single year at the age

of 41 at the age of 42 and then this

goes on and on until the age of 55 where

you're also taking $40,000 I'll accept

at this point you can let off a little

bit on withdrawing from your 401k

hopefully it grows a little bit more

each year and then you have a bunch of

money in your Roth account and hopefully

you want to keep on withdrawing $40,000

away from this Roth account and then

you're gonna keep on draining it

draining it all the way up to your age

fifty nine and a half where you probably

end up with almost nothing left you're

only taking out whatever you contribute

it and then the gains over here you left

untouched and then when you reach 59 and

a half you can go oh I can start taking

this money out and you know you can tap

into your 401k as well if you want to if

you retire really really early I mean

really retire you just throw up your

hands and then go I'm not gonna work

anymore because I have I don't know a

million two million dollars saved up and


have to work it might get a little bit

boring because most of time is just very

boring if you're not applying yourself

if you're just going vacationing for the

rest of your life I feel like this is a

very risky thing because then you have

to rely on this 4% rule you're not

making any money at all and you are

absolutely relying on only the money

that you have left in your retirement

accounts and you know you're crossing

your fingers that this 4% rule is going

to pan out properly even though there's

all this unprecedented events going on

the ever-increasing balance sheet of the

United States to be really really secure

instead what you should look to do as an

early retirement person is to get a lot

of passive income sources so even if

you're not working you're not actually

drawing down your retirement funds so

this is a situation I personally am in

right now because I can definitely kind

of not work and then my youtube income

will probably dry up so this is kind of

like a semi retirement because I still

have to you know produce a little bit of

videos in order to get you know keep the

gravy train going in this census is a

lot more secure than just completely

relying on the money that you already

make and just deciding you're never

gonna make any more money again for

anybody that has any kind of income

coming in like dividends or anything any

amount that you're trying to convert

from your retirement account to a Roth

account it's going to be tacked on top

of whatever that you already earned so

you're going to be taxed at your

marginal tax rate if you already earn

twelve thousand dollars let's say any

amount on top of this it's gonna be at

that marginal tax rate of ten percent so

suffice to say if you're trying to

convert let's say a thousand dollars

you're gonna pay a progressively higher

and higher tax bracket so you are still

gonna have to pay income taxes on this

amount that you convert now what do they

mean by this Roth conversion ladder

right because it's a ladder it's kind of

like CV ladder because you convert it

every single year and this Roth

conversion ladder is a five year thing

so you start one year one year later you

convert some more one year a year later

you convert some more so by the time

five year comes you're gonna be able to

withdraw this money without that penalty

and then when you're later after that

you're gonna be able to withdraw another

sum without penalty again

cuz you had this ladder going on and

then you can just keep this up until you

reach 59 and a half now this actually

only makes sense for people with a

really large retirement account it needs

to be so large that you can do this

conversion all throughout your early

retirement and by the time you hit

retirement age you still have a sizeable

chunk in your retirement account and

then with this amount you can still

retire for the rest of your life now

there are finer points over here because

with the Roth IRA when you take a tax it

when you convert from a retirement

account into the Roth you have to pay

income taxes during that year after

taxes is going to be a slightly smaller

amount within your Roth IRA account it

can grow untaxed so any gains that you

make within this investment account when

you take it out of that Roth IRA account

the portion that you gained let's say it

went from 10,000 to 20,000 dollars right

so you gain another $10,000 this portion

of $10,000 is tax-free now how does this

factor in into the Roth conversion

ladder if you put in ten thousand

dollars five years ago you can only

withdraw $10,000 the games you cannot

withdraw just yet until your retirement

age so with all that said I have to

emphasize that for a lot of people this

Roth conversion ladder is it just sounds

like a unicorn thing it doesn't apply to

a lot of people unless you're someone

that has a huge retirement account

pre-tax and you are willing to just

completely stop working and not be

productive at all which I feel like goes

against what I personally believe in

order to live a fulfilling life I

believe you do not live a fulfilling

life if you somehow convert to a

situation where just sitting on the

beach all the time but I feel like for a

lot of people who applies themselves

during retirement right so it could be

very well that you thought you're going

to not make any money once you retire if

you apply yourself in the right way

somehow somehow money is gonna come in

anyway because you're doing something

that you love maybe you like woodworking

a lot and then you make all kinds of

beautiful stuff and you know somehow

people are paying you for anyway and

then all of sudden all this money comes

in anyway and this is the ideal

situation not everyone can apply

themselves the same way of course so

that's what I think about the Roth

conversion ladder I mean it certainly

doesn't apply to me personally

I would feel very uncomfortable if I

just don't earn any money and just kind

of start drawing down the retirement

account because you know I still have

plenty of years to live if I just remain

idle this is a very risky thing to do

because there's all kinds of inflation

going on that's not under your control

the best bet to hedge against inflation

is to earn current day dollars thanks

for watching this video everybody don't

forget to give me a like comment down

below let me know if you're gonna take

advantage of this Roth conversion ladder

thing and as always don't forget to push

that subscribe button and ring that Bell

icon thanks for watching