I have both a traditional 401k and a Roth 401k from my current company. Yes, I will be taking advantage of the foreign earned income exclusion though when that time comes! 4) where do considerations of paying for health insurance factor into your early retirement calculations since Medicare only kicks in at 65? What do you need to do to establish legal residency for taxes? $3,350 – HSA Good idea, Joe. Early retirees, however, can use their low-income years during early retirement to gradually perform the conversion, tax free. Thanks for doing the research. The taxes they paid on their conversions were far lower than what they would have paid had they made Roth 401(k) contributions from the outset. Success! I am exempt from state taxes right now but will most likely have to pay state taxes in retirement. Wish I had found it sooner, as it has changed my perspective on how to slant Roth vs Traditional. Here you are making pre-tax contributions to the IRA or 401K and then the gradual conversion has nothing to do with finding a backdoor to the income limit, it is about limiting the converted amount to minimize the tax paid. I think you mean $11K + $2K, but the total is still $13K. If a college student wanted to start investing, what account would you recommend they use? Also, this strategy works best if you are at 0% tax bracket in retirement, which will probably not be realistic for me. However, due to a raise/promotion (Yay! You can’t touch your earnings until later without a fee, but you can always take out the money you put in. Do you plan to get a green card? But if you never had a traditional IRA and are at the income limits now, using the backdoor method should be pretty straight forward correct? Only the most intelligent and hardcore people make it all the way to this site :). Also, check out this article on HSAs You could still convert a chunk of it tax free though, since you aren’t going to be earning any other income that year. A high deductible ACA plan can cost easily over $500 a month. If you went with a Roth instead, you’d have to pay more tax and would therefore be investing less overall. The goal is to shuffle things so that you never pay taxes on the money; not at the time of contribution, nor conversion, nor withdrawal. Although I’m FI, I’m not retired yet by choice. Some of the money in the account is from a previous employer that I rollover into the new employer. Roth accounts are by nature better suited to early retirement withdrawal strategies. The rest can continue to grow and you would want to select the best account type to facilitate that growth. Although we’re not eligible for mortgage interest or property tax deductions, I think we will fall under the EITC limits and may possibly be eligible for a few others. If not, where should we be investing our money? 2) In some cases it may make sense to make the original contributions to a Traditional IRA/401k, then withdraw desired amounts from the IRA/401k before age 59 1/2 (yes, PAYING THE EARLY WITHDRAWAL PENALTIES) if the IRA/401k contributions during working years are in a high tax bracket, and the withdrawals in retirement/early retirement are in a low tax bracket. Just an FYI for those that haven’t opened Roth IRA, I suggest opening one (even if it’s only with $100) to start that 5 year period for withdrawing original contributions without penalty. https://www.quora.com/Health-Savings-Accounts-I-am-in-school-now-and-my-HSA-charges-a-monthly-fee-When-I-was-employed-the-employer-paid-the-fee-Is-there-anything-I-can-do-in-the-meantime-to-avoid-the-fee-Transfer-to-another-bank-perhaps. Such a pain! I’m convinced that I’m doing all I can: max out my 403(b), max out my Roth IRA, and put the rest in taxable (haven’t gotten to this last step yet but am hoping to start this year). Antonia, 27, wants to retire in 15 years. There is a second threshold, but that shouldn’t come into play for most people. So what’s the best approach? I can’t find anyone who has written about this strategy online, so I was wondering if you or any of your insightful readers might be able to comment on this plan. Since a Traditional IRA to Roth IRA conversion is taxed as normal income, it could be taxed at a high rate if you make a significant amount of earned income elsewhere. In preparation, we need to build our retirement plans using tools such as Individual Retirement Accounts (IRAs) along with 401(k)s from work. Now that I think about it more, my con #2 might not be so bad either. Esp loved your ‘get a university job’ article. If you are taking money out of the Roth at the same time as putting money into the Roth you net picture really hasn’t changed much. I see in the comments where you indicate $10,000 based on the deduction and personal exemption (single filer) so I’m intepreting that as follows: if I get $20K from capital gains and dividends I’ll pay $0 tax on that (under the income limits) so basically my $10K conversion would be ordinary income that would be reduced to $0 once you consider the deduction and personal exemption. They just removed a bunch of hi-fee mutual funds and TDFs. What is the difference between the administrative costs of the 403b compared to a 401k? I was thinking you would want to have conversions end the year before you take social security, not at age 59.5. At age 40, both investors stop contributing to their accounts and begin withdrawing $18,000 per year from the taxable accounts. The wisdom is that we should pay our mortgage off early to free up money, but after spending days running the numbers, I changed my strategy and am NOT paying off my mortgage early. Whoops, posted my comment to the wrong blog. For example, let’s assume that you expect your federal effective tax rate to increase from 20% while working to 23% during retirement. If you earn more than what’s allowable for a deduction on a traditional IRA, MAGI is higher than $62K in 2017, is there an advantage to funding a traditional IRA and then convert to a Roth or just contribute to a Roth? I’ve looked at it briefly and concluded that I’ll be stuck paying taxes either way, so I may as well use Roth, but I’d love to be proven wrong! Also, since I’m paying the taxes on the conversion, out of a separate, there is definitely and significant compounded cost beyond the tax bill for all taxes paid. Wouldn’t you want to just switch to Roth contributions once you hit those limits? Maybe because I’m an engineer :-). You got it! 1) There is a difference between money that was contributed directly in a tax year from wages, money that was converted to the Roth from an IRA, and the earnings (realized and unrealized capital gains and distributions). Currently earning $66k (single filer) with around $500/month health insurance cost deducted directly. Does the ladder strategy go out the window if someone isn’t able to make it to early retirement and just retires at the more common retirement age? Here are the big ones: At age 48, traditional 401k is worth $4,434,526, and Roth 401k is worth $2,956,351, if you take a 30% tax hit on the traditional 401k, it might be worth $3.1 million, while the Roth is still worth $2,956,351, and then the Roth Account Holder has the $1.4 mil in the taxed account, which after 30% is about $980,000, for a total of $3.9 million. Note: To avoid paying a 10% early-withdrawal penalty, you have to wait five years after the conversion (or until you turn 59.5, if that’s sooner) to withdraw the converted funds from the Roth. Norm, I think the strategy presented in the post is specifically targeting those making less than the deductible traditional IRA limit ($98K in your example), not a general commentary on traditional over Roth. Should I max out rIRA, then traditional? $30K investment income (long-term capital gains and dividends). Only after those accounts are depleted would you draw down your retirement accounts. For example, I want to live on $30K a year in my ER. I read somewhere their is a 10% penalty if you are not 59 1/2 and then read somewhere else that you would have to pay a penalty on the interest/growth of the Roth IRA if you withdraw early, is this not the case and you just have to wait 5 years regardless of age? Thank you so much for your reply – I really appreciate it! Depending on where in California you live, you can call that your weather tax, since I can’t imagine living in most of those states without breaking the bank in AC or Heating costs! You are living “tax free” off of it. Of course CPA recommends a Roth because we’re in a 21% tax bracket (which could be higher in retirement?!?) If it is a smaller company perhaps she can rally her co-workers and talk to HR and slip in the word fiduciary. It’s been an AMAZING help for this FI newbie! Do you do your taxes yourself using an online tool like TaxAct or TurboTax? I think the 5k from the traditional IRA fund really should be treated as the “last” 5k in the context of traditional vs Roth because if you had used a Roth you would only have 15k of taxable income rather than 20k with the other 5k coming from your Roth. But that tax structure has only been in place since 2008. She has a terrible 401(k) plan at work, but since she has a 401(k) plan at all, the tax deduction for a traditional IRA gets phased out starting at $98,000 MAGI for us. Money saved for everyday living outside of a retirement account of any flavor (not an IRA, Roth, 401k, 403b, 457, etc). Point (2) obviously does not apply to roth 401’s. This means you just need to have contributed enough to your Roth to last you those first 5 years of retirement, and then make sure you rollover enough from your other retirement accounts each year so that 5 years down the line when it becomes available, you live on the now-free-to-withdraw funds. I read this post for the first time about a year ago when my wife and I began DIY financial/early retirement planning and it was the first time that tax planning made sense to us. When you do a rollover from a Traditional IRA to a Roth, the rollover amount can be withdrawn prior to age 59.5, penalty-free, but you have to wait five years after the rollover. Just make sure you don't make too much to contribute to a Roth IRA ( <$133,000 for single, <$196,000 for married filing jointly). My aim is to keep my taxable income right around $14K to $15K in the first years of retirement to get a great healthcare subsidy (while it still exists). SEPPs could work too but there are limits to how much you can actually withdraw, as you mentioned, and I don’t really like the idea of being forced to continue the withdrawals when I may not actually need the money. Welcome, Tom! Wow, excellent article and strategy if you have enough in non-retirement qualified dividends to live off while converting to Roth IRA. Can I use the IRS deduction if my medical bills exceed 10%? However, I have recently decided that I need some diversification (at the very least in some tax-advantaged retirement accounts). The fees are not bad and the investment choices are mostly Vanguard funds (that I have). However, if you didn’t withdrawal from the IRA the deductions would still lower your taxable income to 20k vs 29k, thus the IRA withdrawal increases your tax bill? Why do I listen to “conventional wisdom” vs thinking for myself?? In retirement, Kevin is able to spend all $210 without having to pay any additional income taxes. My children need your taxes :). Is the traditional IRA still a good deal? Thank you for this post. You said in your post that we should contribute to an Traditional IRA during your working years for the tax deduction on your income but what if your AGI is over limit >$72,000 limit resulting in no tax deduction. FI – Thanks for this post; it leaves me with lots to think about. Yes, the conclusions definitely change at that income level because as you said, you would no longer benefit from any tax deductions. Keep up the great work! This is why the traditional 401(k) vs. Roth 401(k) decision is irrelevant if your income-tax rate is the the same in your working years and in retirement. Having these two pieces of information can do a lot to clarify whether you should be contributing to a traditional 401(k) or a Roth 401(k). So I’ve scrolled through countless comments and still haven’t found my answer. At $50K income you could use the MF’s strategy and put it in a trad IRA for later conversion. 5) My risk tolerance is high so I’d go with Vanguard but you just need to do whatever makes you most comfortable. Thank you for the plethora of information and the assistance you provide to everyone! No, you’re definitely not the first to get here via MMM. I’ve tried reading through the US-France tax treaty but it’s not easy to understand. Hello! One dollar more than that you enter the deduction phase out Please forgive me if this was already mentioned, but there are a TON of comments in this thread, and I didn’t make it through all of them…. More than half of my income producing assets are in taxable accounts and I just am not sure how much taxable passive income I’ll actually generate. How would paying taxes now to contribute to a Roth (or straight to a taxable account) be more advantageous than paying taxes much later at a lower tax rate? I’m in a similar boat as Justin – I make “too much” for tIRA deduction, but also income level with married-filing jointly makes us ineligible for a Roth IRA. Before age 60? The Backdoor Roth is for people whose income exceeds the income limits for a Roth IRA. Is it not the deductions you can take during early retirement that make the Traditional IRA to Roth IRA conversion tax-free that make this strategy beneficial? 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