Here's how you can use a Roth conversion ladder to save taxes in the future

Swedish | E+ | Getty Images

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.

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

More from Personal Finance:
The right mix of retirement accounts can lower your future taxes, experts say
Uncertainty over Biden's re-election could spell trouble for student loan borrowers
Federal Judge Partially Blocks FTC Ban on Non-Compete Agreements: What It Means for Employees

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 exercise,” says Lawrence. “You have to revisit the planned renovations every year and make adjustments where necessary.”

'Unlock' your pension funds sooner

As with regular Roth conversions, one of the key benefits of the conversion ladder is tax-free “compound growth on future gains,” said Cherry, who is a member of CNBC's Council of Financial Advisors.

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 generally a 10% early withdrawal penalty on 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 is subject to a separate five-year period.

There is also a five-year rule for Roth IRA accounts, meaning the account must be open for at least that long to avoid taxes or penalties, even after age 59½.

The Rise of the 'Silver Squatters'

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.

Don't miss these insights from CNBC PRO

Related Posts

  • Finance
  • July 19, 2024
  • 1 views
  • 6 minutes Read
What You Need to Know About Airline Refunds and Delays

Travelers wait in line at a Delta Airlines counter at Ronald Reagan National Airport in Arlington, Virginia, on July 19, 2024. Airlines around the world faced unprecedented disruptions after a…

  • Finance
  • July 19, 2024
  • 2 views
  • 2 minutes Read
Global technical outage hits financial services provider Charles Schwab

Pekic | E+ | Getty Images Amid widespread global IT outage, some investors experienced disruptions at financial services firms on Friday, including Charles Schwabone of the largest real estate agencies…

Leave a Reply

Your email address will not be published. Required fields are marked *

You Missed

History of US Soccer at the Olympics: USWNT Success Defines Them, USMNT Returns After 16 Years

  • July 19, 2024
History of US Soccer at the Olympics: USWNT Success Defines Them, USMNT Returns After 16 Years

Chinese make their own cooking oil after scandal raises concerns

  • July 19, 2024
Chinese make their own cooking oil after scandal raises concerns

Connecting an antenna to a TV: watch movies, series and sports for free

  • July 19, 2024
Connecting an antenna to a TV: watch movies, series and sports for free

A Guide to Your Weekend Viewing and Reading Pleasure: NPR

  • July 19, 2024
A Guide to Your Weekend Viewing and Reading Pleasure: NPR

What You Need to Know About Airline Refunds and Delays

  • July 19, 2024
What You Need to Know About Airline Refunds and Delays

NFL kickoff rules for 2024 could create excitement…and chaos: 'It's going to be a show'

  • July 19, 2024
NFL kickoff rules for 2024 could create excitement…and chaos: 'It's going to be a show'

European markets: open to closed

  • July 19, 2024
European markets: open to closed

Investors are betting on the 'Trump trade'. Here's what it means.

  • July 19, 2024
Investors are betting on the 'Trump trade'. Here's what it means.

Scientists find new target for RSV drug

  • July 19, 2024
Scientists find new target for RSV drug

DOJ says largest housing provider for migrant children involved in widespread sexual abuse

  • July 19, 2024
DOJ says largest housing provider for migrant children involved in widespread sexual abuse

Video shows reclusive tribe searching for food on Amazon beach

  • July 19, 2024
Video shows reclusive tribe searching for food on Amazon beach