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Am I interpreting this correctly? Thanks for all your good work! This is exactly what I have been doing since I stopped working in at age I have paid a little in state NC income tax. But now, a new consideration. The way to get the largest subsidy is to have your MAGI be as low as possible. At low income levels the tax credits are substantial — hundreds of dollars a month, or thousands over a year.
Thanks a lot for the comment, xyzzy. I must have had the Earned Income Tax Credit on my mind or something. I think this point needs to be addressed further, as I think it is very important. Early retirees are going to most likely have a lower income levels and thus a lot of us will rely on the ACA to help subsidize our health care costs. I think we need to run some numbers to see how this effects our amount we can convert vs how much is lowers our discounts on health care. One of the things has kept us from declearing FI is health care costs.
The ACA even in California is much more expensive that people want to admit. Just found your podcasts this week and they are very useful and interesting. I left my job almost 4 years ago when I was It will be my first time using my TEFL degree so should be interesting. This would ensure that I get all my money into the Roth account.
Congratulations on already being done with full-time employment. It will also help for when I have to get health coverage next year. This year I should be exempt. As I understand it, if you spend days of the year outside of the US you are exempt. I just listened to the Lacking Ambition podcast and you mentioned potentially doing a Habitat for Humanity project down the road to pick up some building skills. Another organization to look at is All Hands Volunteer hands.
The one downside is you have a lot less say in where you go as they only respond where there have been emergencies.
Thank you very much for the All Hands Volunteer recommendation. Brian Setzer, If you are out of the country most of the year you also get a substantial income tax exemption. Let me clarify, I now understand that the 25k is cap gains and dividends and interest?
Thank you very much — I see I should have dug through the other questions… Maybe you could add a note about this in step 2 since it looks like there have been several of these questions. Another followup — Am I right that you wrote this article as though you were single even though youre married? And if you had children, it would be an additional 4k roughly per child. I would imagine that you are going to get your k by maxing out and reinvesting to quite possibly exceed that amount by Hey, yeah — I think the note will help future readers.
Thanks a lot for answering my questions. You might see some more from me regarding the more contentious asset allocation issues…. When exactly are you suggesting you do this? The comment above was meant for after you quit working. My thinking was that since you need income to invest in a roth, the act of moving the money would constitute income and allow you to make this transaction.
Thus allowing you to move 15k rather than 10k per year. Of course you would still have to stay under the 45k of income above — but does this make any sense?
So let me make sure I understand this. On year 5, you are then able to take out 10K tax free I know Roth contributions could be taken before but can your conversion assuming you wait 5 years and it contains earnings be taken before Yes, the conversion can be taken without penalty after 5 years but not the earnings.
Hey, have you come across plans. Also, a question about this post in general. Say I decide to retire at 65, and have little earned income.
I could be converting Trad to Roth with no income tax as well. This blog combined with jlcollins has taught me more about investing than any other source! I have a few questions. I would like to semi-retire in about yrs. I plan to stay with this company for yrs. Is that the right call? Would you still suggest a traditional over a Roth? At least you only have to deal with the high fees for years.
Once you leave your job, you should be able to roll the k over into a Vanguard IRA and can take advantage of the great index funds there. They can pass your request along to whatever management company they may be using for the k and they can add new fund options for you. Either way, Mad Fientist makes a good point that: Is there any potential disadvantage to starting this conversion 5 years pre-ER, so that it is ready to go right away? Is there an income tax disadvantage to doing the conversion during our working years?
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. If you instead wait to start the conversion when your income is significantly lower or when your income is coming from more tax-efficient sources like long-term capital gains and qualified dividends, you could pay very little tax or none at all on the conversions.
Is the conversion to be taxed at your current rate seen as income to influence your taxable rate? Yes, the conversion is treated as income so conversions could bump you into another tax bracket. James, you can withdraw contributions to a Roth IRA at any time and you can withdraw Traditional-to-Roth conversions after waiting five years, all without penalty. While 72 t substantially equal periodic payments is one way to get money out of any IRA early, the rollover strategy described in this post and in greater detail in this post is a more optimal method, in opinion.
Could I get a copy of the spreadsheet you used to create the graph? Being the great software engineer that I am I strongly believe in re-use! Had a question about the 5 year rule — when would be the best time of year to perform the rollover? I was reading that the 5 year timer starts Jan 1 of year of rollover; I read this to mean that you should be doing a rollover in December, when you understand your tax year implications, and you still get credit back to Jan 1.
Have you figured out your timing as you head into FI this year? As you mentioned, if you want to access your money as soon as possible, it makes sense to do your conversions later in the year. As a 27 year-old who has only recently begun to realize that financial independence is possible, you are an inspiration.
Thank you for making this information available and easily digestible. Could you point me to a decent crash-course on retirement investing for us self-employed folk? Assuming I can make similar contributions each year, would the SEP likely be the primary retirement vehicle for a person like me? I found this Forbes article about the IRA conversion you speak of: Do your calculations take this into account? I can see where you could do a lot of math and figure out the ideal amount of tax you want to pay and base your conversion amount per year on that … Please point me in the direction of such an article explaining this — or write one for us!
Wow, thanks for your response! Understanding this stuff feels like a real job — but at least it pays handsomely. To get around the Roth income limit, what you can do is contribute to a non-deductible Traditional IRA and then immediately roll over that money into a Roth.
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? I expect to have the properties paid off before any conversion would happen. In my scenario would it just be better to place my surplus funds in a taxable account? My k plan description mentions rolling the k into a Roth IRA.
If this is possible, does it eliminate the need for the intermediate step of rolling the k into a traditional IRA? Hey Eric, yes, that would remove the intermediate step.
We max out two bs and two Roth IRAs and get employer match. Right now, we do not have any significant accumulation in a taxable account. This would make ER before 55 difficult. Also use the withdrawals of Roth IRA contributions for living expenses.
This would minimize taxes. This would be a ladder with a five year wait. Sounds like a pretty good plan to me! Check out this post and this post for more on the Roth conversion ladder strategy. For a while, I had been obsessing over the lack of enough taxable accumulations to fund ER.
But with this strategy it is possible. Yeah, realizing that I could easily tap my tax-advantaged accounts early without penalty really changed how I approached saving for FI. I fund both the accounts: I agree that tax diversification can be a useful strategy especially if you have plans for early retirement. How much of your taxable account is safe to withdraw? How much would I need in my taxable account and tax advantaged accounts to do so? I doubt my situation will change before my retirement.
In that case, would you suggest I do my k and a Roth using the Roth contributions to live on until I come of age. Your strategy of funding a traditional k and slowly converting it to a Roth k when FIREd sounds appealing. I am thinking about one downside though: So any additional investments might have to go in taxable accounts. That might allow me to sock more of my money away into tax-free accounts.
Have you thought about this yet? Have you done one of those charts where you compare the net worth over time between these two options? This is because when contributing to a traditional k , part of the invested money will eventually be taxed.
Now, I still think your traditional-to-Roth conversion strategy is great and probably worth the cost of being able to shelter a little less money from capital gains taxes. I thought you said you are already maxing out all of your retirement accounts?
I think the best way to decide on Roth vs Traditional is to try and make your taxable income for every year to be in the same tax bracket or as close to it as possible. As close as you can to the same while working, the same while in early retirement and the same while in regular retirement. This is sometimes hard to figure out because calculating your RMD required minimum distributions can be difficult. Lastly thank you for introducing me to HSAs. Any opportunity for me to lower my taxable income is worth investigating.
So when you retire and you are married filing jointly and you are trying to do the conversion. You can transfer around 10, from an ira to a roth ira tax free via the standard deductions per person. Can you stll transfer all 20k in this way or does the spouse have have a certain amount of it in their account. Do you have to be careful to make sure you have things listed in accounts with joint ownership?
If tax law stays the same and without any side income after reaching FI, this would be the way to go. Does this scenario assume you have money in a taxable account? I am planning to have almost all of my savings in tax-deferred accounts. I was thinking you would want to have conversions end the year before you take social security, not at age If you have everything converted into Roth accounts by Bottom line up front: I need some input in building an Excel calculator to maximize Roth Conversion.
Find the best theoretical conversion amount for each year, for up to 40 years, that will completely drain the b, and minimize the taxes paid and the lost time-value of paying taxes earlier rather than later. Since the b theoretically continues to grow each year, the conversion amount must compensate for both reducing the principle and any interest. I think this was because I took out just enough so that smaller payments would amortize the rest of the conversion in the time allotted, without killing myself by paying too much in taxes in the early years.
Any help would be appreciated. That may be a cool calculator to add to the FI Laboratory. I have similar tax minimization and backdoor Roth conversion calculations as he does, and would either love an easy calculator to run scenarios, OR any referrals to reputable fixed fee tax advisors that you or your MF community can refer me to. Preferably tax advisors in Northern California. You can definitely do it! Any comments on the strategy are appreciated. Do you do your taxes yourself using an online tool like TaxAct or TurboTax?
Thanks for the insightful article. A caveat of this strategy is that during the time period when money is invested in tax-deferred instead of tax-free account, any earnings would be fully taxed at ordinary income rate at conversion.
Thank you for all your well-researched articles. Between MMM, jcollins, and you, I have a lot to learn…. Does this make sense from your perspective? Do you still recommend a traditional IRA even if it will be non-deductible over a roth? I am already maxing out my K and HSA. If you can only contribute to a non-deductible Traditional IRA, you might as well just go with a Roth.
You are masterful at taking our ridiculously complicated tax code and simplifying it to demonstrate how big of an impact we can have on our financial situations by paying attention to a few key details.
Hi MF, Love the content. My question is this: I have a portion of income that is not taxed at all, enough that I can max out contributions to a Roth or Traditional IRA, along with the k in either flavor also. Or is it better to invest in the Traditional versions to push the effective tax even lower??? If none of your income is taxed anyway, you should just go directly into the Roth so that that money is never taxed. Thanks for all this information! In time I hope to understand it all, or at least a lot more than I do right now as a self-confessed and slightly ashamed newbie!
As I said, a newbie. How does this work out for those of us in states where traditional IRA contribution are taxed? Is the traditional IRA still a good deal? I think it is, but it makes things a little more complicated for some. Are you aware of this? And if so, do you have a backup plan? Hey Richard, check out this post! Great article, you wrote about things I have never even thought about, and that is amazing given my CPA certification.
Your analysis has proven me wrong. I do not think I have enough to live on for the five year period. Is there anyway around this? I have almost enough to retire today, though, at age Would you recommend a home equity line of credit, interest only with a 10 year period, to fund early retirement, take the tax deduction IF you itemize, and forgo an early withdrawal penalty, while you wait and convert?
Hi Dan, why not just work part time doing something you enjoy to pay for your expenses for the first five years?
Thank you so much for what you do for others, and especially for young people like me. I am 25 years old, and after following your advice, I started a Roth account and a brokerage account. I apologize for bothering you, but could you kindly help me with a calculation?
I just received a job offer with the following terms:. I understand there are restrictions but i am not sure how they are calculated? Check out this post that my buddy Jeremy at Go Curry Cracker wrote. If you do a rollover to a Roth, you just have to pay taxes on that rollover but you could then take that amount out of the Roth, penalty free. I am currently living abroad and we are thinking of traveling for a year or so prior to returning to America and not making any income.
Would I be able to convert to Roth and not pay any taxes and use the foreign earned income exclusion? If so, that would be sweet! Can I get your help on a general plan of action for the next 10 years maybe less? I have some immediate plans to save on taxes by moving to a no-state income tax area, or even go out of country to get the federal income exclusion.
But what should we be doing with our investments in order to follow your path of early retirement? Total net worth right now is about 1MM mostly in our house though: Hey telecommuter, check out this post and this post for why maxing out your tax-advantaged accounts could really supercharge your savings while you are both still working!
Were you able to take advantage of the foreign income exclusion? Yes, I will be taking advantage of the foreign earned income exclusion though when that time comes! The foreign earned income exclusion is only for Federal Taxes, right? Is there an equivalent exclusion for State taxes?
I learned about GCC this past week and found this article through them. You all have made it seem very realistic and doable and I am now addicted to your blogs. Thank you for the plethora of information and the assistance you provide to everyone! Not sure how those things would factor in or not. Here are a couple of posts that highlight why I think the Traditional route is best for those hoping to retire early though: Does a restriction exists to withdraw monies in an IRA? Does the money has to sit in the IRA for a minimum of five years?
Does an age restriction exists for widthdraws? When you do a rollover from a Traditional IRA to a Roth, the rollover amount can be withdrawn prior to age Depending on how you have things setup and your drawdown plan. So it might look something like this: My plan is to live entirely off of dividend income, so I was concerned that too large a percentage of that dividend income would be tied up in the Roth.
But you are right that turning the tax-free growth into taxable growth, just so that I can access it earlier, is too much of a sacrifice. I made a contribution to a Roth, realized my AGI would fall under the threshold and put the money back in a traditional IRA for the tax savings. Would you happen to know? I currently love my job and could see myself here until regular retirement, but the future is uncertain and you never know what will happen even 5 years from now.
Phil, did you ever get an answer? I too will probably not retire crazy early, maybe not early at all, but I still want to be making the best decisions. Wish I had found it sooner, as it has changed my perspective on how to slant Roth vs Traditional. I saw in another post you mentioned an interest in looking into property management, so I wonder if you have thought how this would impact your laddered conversions.
My husband and I have 9 kids at home and a single income. We also have two rentals, one of which we are selling when it becomes vacant in July. Any thoughts or suggestions for our situation would be welcomed. Hi, I have learned a lot from your site and jlcollins site. Thank you for sharing the knowledge. I think you need to update your article to include the loss of ACA subsidies due to the Roth conversion increase in income.
Once this is factored in it almost becomes uneconomic to do the conversion. If you figure a way around this I would be all ears. I assume most early retirees will face this. I seem to be missing some vital bit of information.
How then is one able to make a transfer of funds to a Roth IRA and skirt this penalty starting at age 40? I know this article has been up for a while, but hoping someone smarter than me has some thoughts….
I have been following this strategy and contributing to an IRA in addition to maxing out my employer-sponsored K. Does this change the strategy? Should I worry about maxing out my tax sheltered accounts and using the IRA ladder , or would I be better off using that money to get more real estate?
I was curious how you file your taxes, i. I was listening to one of your podcasts and reading the post in the roth ira ladder. But you said your wife does and will work probably longer than you so how do you avoid her taxable income raising your joint income while you are performing these roth conversions?
You do a great job and I have learned a ton! Thanks for all the education. I need this tax knowledge. I learned a lot from the information! Hey all, just want to make sure I understand something.
Hey MadFientist, Just came across this from another blogger. Wow I punched in numbers and I could convert 50k a year to a Roth if all goes according to plan without paying taxes on it. Thanks for doing the research. You have changed my mindset on what investment vehicle to choose. What Traditional IRA would you recommend? It appears Vanguard has a number of options available. Also how much should be put in for best yield?
You cannot take a tax deduction i. Without the tax benefit up front, the Roth IRA wins out. Contributions to your k or b , b , HSA, and your standard deduction and personal exemption should be subtracted from your gross income to calculate your MAGI. I work for a state university, and have access to a b.
I had a question about how contributing to a Roth vs. Traditional in a State with no income tax, like Texas, changes the decision. I was always under the assumption since having no income tax is such a great benefit, I should contribute to a roth account. However, based on another post you made here http: I am now contributing to a Traditional IRA and k but every year I seem to go back and forth between which is better.
If I make roughly 50K a year and is the head of household, what benefits do I get around tax time? It also seems like a TRAD vs. Roth is the best idea. At lower tax brackets, that savings might not be that much. If you plan on retiring to a state with taxes, you would want to move your money to the Roth before you go. This tips the scales in favor of Traditional contributions for even more people.
I found this article that discusses some of the ramnifications: What the effective tax rates are on your contributions is very relevant. Depending on the expected effect tax rates, it might never make sense to contribute to a Roth regardless of how much income you can generate.
If something sounds too good to be true e. So if someone owned their own business and could set up an individual k via vanguard and funnel business and personal contributions to that up to 18k limit for individual and 56k total max per year, according to the vanguard site: Would you recommend maxing that out that before setting up an IRA? I guess it would depend on which one lowered the tax bil the most, ya? I do have a question though, does this guidance change for going folks working towards FI that are constantly maxing their ks?
Assuming one maxes it for fifteen years or so straight out of University and has a total contribution of over k before gains does it bring up the Roth vs IRA debate again?
Not helpful when you make more money than the income limit! I used to be in the boat of maxing out taxable accounts to fund early retirement. My wife also has access to a b account which is the best of both worlds. Standard mileage and other information. Instructions for Form Request for Transcript of Tax Return. Employee's Withholding Allowance Certificate. Employer's Quarterly Federal Tax Return. Employers engaged in a trade or business who pay compensation.
Popular For Tax Pros. Apply for Power of Attorney. A Roth IRA can also be an individual retirement annuity , which is an annuity contract or an endowment contract purchased from a life insurance company. A Roth IRA's main advantages are its tax structure and the additional flexibility that this tax structure provides. Also, there are fewer restrictions on the investments that can be made in the plan than many other tax-advantaged plans, and this adds somewhat to their popularity, though the investment options available depend on the trustee or the place where the plan is established.
The total contributions allowed per year to all IRAs is the lesser of one's taxable compensation which is not the same as adjusted gross income and the limit amounts as seen below this total may be split up between any number of traditional and Roth IRAs.
In the case of a married couple, each spouse may contribute the amount listed:. In , then Senator William Roth R-Del wanted to restore the traditional IRA which had been repealed in , and the upfront tax deduction that goes with it. Under congressional budget rules, which work within a year window, the revenue cost of giving that tax break to everyone was too high.
So his staff limited deductible IRAs to people with very low income, and made Roth IRAs initially with income limitations available to others.
That slid the revenue cost outside the year window and got the legislation out from under the budget rules. Economists have warned about exploding future revenue losses associated with Roth IRAs. With these accounts, the government is "bringing in more now, but giving up much more in the future," said economist and Forbes contributor Leonard Burman.
The losses stem from both Roth conversions and the ability to make nondeductible IRA contributions and then immediately convert them to Roths. Transactions inside a Roth IRA including capital gains , dividends, and interest do not incur a current tax liability.
Double taxation may still occur within these tax sheltered investment plans. For example, foreign dividends may be taxed at their point of origin, and the IRS does not recognize this tax as a creditable deduction.
For Canadians with U. Internal Revenue Code and similar plans are considered to be pensions. Accordingly, distributions from a Roth IRA as well as other similar plans to a resident of Canada will generally be exempt from Canadian tax to the extent that they would have been exempt from U. Additionally, a resident of Canada may elect to defer any taxation in Canada with respect to income accrued in a Roth IRA but not distributed by the Roth IRA, until and to the extent that a distribution is made from the Roth IRA or any plan substituted therefor.
The effect of these rules is that, in most cases, no portion of the Roth IRA will be subject to taxation in Canada. However, where an individual makes a contribution to a Roth IRA while they are a resident of Canada other than rollover contributions from another Roth IRA , the Roth IRA will lose its status as a "pension" for purposes of the Treaty with respect to the accretions from the time such contribution is made. Income accretions from such time will be subject to tax in Canada in the year of accrual.
In effect, the Roth IRA will be bifurcated into a "frozen" pension that will continue to enjoy the benefit of the exemption for pensions and a non-pension essentially a savings account that will not.
Congress has limited who can contribute to a Roth IRA based upon income.