Using Roth IRA contributions in early retirement

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Merry
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Using Roth IRA contributions in early retirement

Post by Merry »

Hello! I’m editing my OP with more details. Our question is if we withdraw Roth IRA contributions and then replenish the funds with Roth conversion ladders, essentially is it the same as if we would have left the Roth IRA alone and used the 401k?

Background:
Spouse and I will be “early” retiring soon. We have a large portion of our funds in retirement accounts so the challenge for us is access to funds in the early years until ages 59.5, which is the earliest without the 10% penalty. I’ve always thought we should leave the Roth IRA alone to grow and use our 401k to reduce RMDs, but if I replenish the Roth IRAs with the Roth Conversion ladders in Option 2, it doesn’t really matter, does it?

Withdrawal/Spending Options:
Option 1: Use 72T to withdraw $30k annually from 401k (this will keep us at a low enough income level for a good ACA health plan), fill in remaining $30k expenses with cash. This option doesn’t use any of the original Roth IRA so those funds are left to grow tax-free, but they’d be there if we wanted to make large purchase (sailboat). Extra care will be needed to understand and manage the 72T so we don’t make a mistake but once set up it’s the same and reliable.

Option 2: Roth conversion ladder $30k withdrawal from 401k to Roth IRAs. We wouldn’t have access to those funds for the first 5 years so we’d need to rely on our cash and would need to withdraw out of our Roth IRA contributions. For example in years 1-5 we’d use $48k cash and $12k Roth IRA from contributions. Then years 6-8 we’d be able to use the $30k out of the Roth IRA and $30k Roth IRA from contributions. Therefore this option has 5 years of ladders unused at $150k that remains in Roth IRA- essentially using the Roth IRA but replenishing it.

Each option withdraws the same amount from 401k and uses the same amount of cash. Option 2 needs to use Roth IRA contribution funds to work but replenishes the funds. So both options are pretty close in terms of the Roth IRA balance, right? We could view the funds being used in the options I described as fungible, right?

Getting this question out of the way frees me up to think about the other pros and cons of the Options. The biggest detractor of the 72T is the set-up and inflexibility but it does keep all of the Roth IRA contribution balance available for a large purchase (we are seriously considering a $200k sailboat). Option 2 is maybe easier but we’d have to find a way to buy the sailboat with a loan. Thoughts on these options?

Thank you!
Last edited by Merry on Tue Aug 30, 2022 8:58 am, edited 2 times in total.
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ruralavalon
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Re: Using Roth IRA contributions in early retirement

Post by ruralavalon »

Merry wrote: Fri Oct 15, 2021 10:32 pm Hello! Our question is if we withdraw Roth IRA contributions and then replenish the funds with Roth conversion ladders, essentially is it the same as if we would have left the Roth IRA alone and used the TSP/401k?

Background: Spouse and I will be “early” retiring in a couple of months at 48 and 50. One strategy is we’d do a 72T Sepp and have income right away but it would be very inflexible. The other strategy is to do a Roth conversion ladder which would maintain our flexibility but we wouldn’t have that as income for the first 5 years. We do have some savings but would need to withdraw out of our Roth IRA contributions in those early 5 years. I’ve always thought we should leave the Roth IRA alone to grow, but if I replenish it with the Roth Conversion ladders, it doesn’t really matter, does it?
I don't think that is enough information to answer your question.

Please give a complete picture: Asking Portfolio Questions.

Please simply add this to your original post using the edit button (the pencil icon near the upper right corner of your post), it helps a lot if all of your information is in one place.

Off the cuff it sounds like a lot of extra effort for no real benefit, but without the full picture it is hard to say.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link: Bogleheads® investment philosophy
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retiredjg
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Re: Using Roth IRA contributions in early retirement

Post by retiredjg »

Merry wrote: Fri Oct 15, 2021 10:32 pm Hello! Our question is if we withdraw Roth IRA contributions and then replenish the funds with Roth conversion ladders, essentially is it the same as if we would have left the Roth IRA alone and used the TSP/401k?

Background: Spouse and I will be “early” retiring in a couple of months at 48 and 50. One strategy is we’d do a 72T Sepp and have income right away but it would be very inflexible. The other strategy is to do a Roth conversion ladder which would maintain our flexibility but we wouldn’t have that as income for the first 5 years. We do have some savings but would need to withdraw out of our Roth IRA contributions in those early 5 years. I’ve always thought we should leave the Roth IRA alone to grow, but if I replenish it with the Roth Conversion ladders, it doesn’t really matter, does it?
Withdrawing from Roth IRA and doing a Roth conversion in the same year is essentially the same as taking money from TSP/401k (assuming equal amounts) except that the conversion also requires the tax to be paid from savings (at your age). However, these two things are treated differently in your taxes.

Withdrawing and converting do not require a SEPP arrangement. Taking from 401k/TSP/IRA do require a SEPP arrangement that will last 9 to 11 years and which can be very inflexible. I would avoid the SEPP myself if there is another choice. If it cannot be avoided entirely, I'd do something else until 54.5 and then do a SEPP to shorten the length of the SEPP.

Is the 50 year old in a federal public safety job by any chance? If yes, the TSP can be tapped with no penalty by a PSO with the required years employment, no SEPP required. I think the same is true for non-federal PSOs, but there may be more to it.
Topic Author
Merry
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Re: Using Roth IRA contributions in early retirement

Post by Merry »

Thanks ruralavalon and retiredjg! I’ve updated the OP with more details.
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retiredjg
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Re: Using Roth IRA contributions in early retirement

Post by retiredjg »

Not sure you included the taxes on the Roth conversions coming out of savings.

I don't see any benefit from using a SEPP myself. Your Roth money is not so precious that you should not spend it.

Things were humming along fine for me until we got to the sailboat. I know nothing about sailboats, but my understanding is that certain things in life are just expensive to keep - it seems that horses and sailboats fit into this category. It made me wonder if your meager income is going to cover all the possible out-gos that something like a sailboat might entail.

I can see dozens of ways for financial things to go south, especially since boats and weather events tend to find each other. I would not want to be enslaved by a SEPP agreement in a case like this.

I don't know if you have enough to retire or not, but getting into 8 and 10 or 11 year SEPPs would not be high on my list. I'd rather go it without the SEPP, use plan B, and pay the 10% penalty on taking money from TSP/401k/IRA if a shortfall occurs. In other words, I'd rather pay a fine on a small amount occasionally than have my financial life tied up that long with a SEPP.
WhiteMaxima
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Re: Using Roth IRA contributions in early retirement

Post by WhiteMaxima »

One should use pre-tax IRA for early retirement to reduce future RMD and potential 65 medicare IRAMa. Roth only used to filing the gap your tax bracket
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JoMoney
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Re: Using Roth IRA contributions in early retirement

Post by JoMoney »

FWIW, If a "Roth IRA Conversion Ladder" is being used for early retirement withdrawals, I don't believe the taxes on the conversions necessarily have to be paid "out of savings" if that is meant to imply a taxable savings account.
If the amount being converted from taxable IRA to Roth IRA is the same as the amount withdraw from Roth IRA each year, they can simply pay the taxes out of their Roth IRA withdrawals. If their Roth IRA custodian allows for withholding, they can even setup the tax withholding to be taken out of those withdrawals and not have to concern themselves with making quarterly estimated tax payments (they pay the taxes through withholding.)
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Wiggums
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Re: Using Roth IRA contributions in early retirement

Post by Wiggums »

I am not a fan of Substantially Equal Periodic Payments. With a SEPP plan, funds are withdrawn penalty-free through specified annual distributions for a period of five years or until the account-holder turns 59½, whichever comes later. Income tax must still be paid on the withdrawals.
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JoMoney
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Re: Using Roth IRA contributions in early retirement

Post by JoMoney »

WhiteMaxima wrote: Sun Oct 17, 2021 11:26 am One should use pre-tax IRA for early retirement to reduce future RMD and potential 65 medicare IRAMa. Roth only used to filing the gap your tax bracket
If "early retirement" withdrawals means having to setup an inflexible SEPP/72t plan or pay 10% penalties, that does not seem optimal.
Not everyone looking at early retirement will have so much money in taxable IRAs combined with other income that RMD's need to be avoided, or incomes high enough that medicare IRMAA will even be an issue.
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retiredjg
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Re: Using Roth IRA contributions in early retirement

Post by retiredjg »

JoMoney wrote: Sun Oct 17, 2021 11:28 am FWIW, If a "Roth IRA Conversion Ladder" is being used for early retirement withdrawals, I don't believe the taxes on the conversions necessarily have to be paid "out of savings" if that is meant to imply a taxable savings account.
If the amount being converted from taxable IRA to Roth IRA is the same as the amount withdraw from Roth IRA each year, they can simply pay the taxes out of their Roth IRA withdrawals. If their Roth IRA custodian allows for withholding, they can even setup the tax withholding to be taken out of those withdrawals and not have to concern themselves with making quarterly estimated tax payments (they pay the taxes through withholding.)
I see your point. I was assuming the Roth IRA withdrawal was all for living expenses but there is no reason that taxes could not be included in that amount.

My main point is that the taxes cannot be paid from the TSP or IRA without a penalty.
KlangFool
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Re: Using Roth IRA contributions in early retirement

Post by KlangFool »

OP,

1) In my opinion, you are asking the wrong question and thinking the wrong way. The correct way is

A) Keep 2 to 3 years of expense in CASH.

B) Roth convert and refill the CASH buffer every year in the most tax advantageous way.

C) Dis-connect your annual expense need from the actual withdrawal/conversion.

D) The tax law may change. And, whatever you plan now may not work as well when the year come.

E) Be flexible.

2) Please read this thread.

viewtopic.php?t=87471
"How to pay ZERO taxes in retirement with 6-figure expenses"

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teen persuasion
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Re: Using Roth IRA contributions in early retirement

Post by teen persuasion »

No comment on the sailboat idea, but using a Roth ladder before reaching 59.5 has always seemed equivalent to spending directly from tIRA to me.

I'm planning to Roth convert each year, and withdraw from previous Roth contributions an amount = (or <) for spending. So I'm simultaneously withdrawing (indirectly from tIRA), avoiding any 10% penalty, and limiting the growth of the tIRA and future RMDs.

If I convert more than I withdraw, our balance shifts to Roth over time.

If I convert an amount greater than the annual growth within the tIRA, I can shrink the tIRA (smaller future RMDs) over time.
Topic Author
Merry
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Re: Using Roth IRA contributions in early retirement

Post by Merry »

Thanks all for the opinions! Yeah the sailboat may just need to remain a dream but I didn’t want to make a decision today that would preclude it in the future!

I considered taxes for both options essentially equal because they need to be paid when taken from the TSP either way.

Sounds like I’m putting too much thought into the Roth IRA balance question. And what I’m gathering is the group so far doesn’t favor the 72T Sepp and we should make it work with the Roth conversions. That’s how we’re leaning but wondering if there’s anyone out there that would argue the 72T Sepp is best for our situation.

Thanks again!
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retiredjg
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Re: Using Roth IRA contributions in early retirement

Post by retiredjg »

Merry wrote: Sun Oct 17, 2021 9:20 pm I considered taxes for both options essentially equal because they need to be paid when taken from the TSP either way.
You may have just used the wrong wording here, but do not pay the taxes out of the TSP money. That will be an early withdrawal, triggering a penalty. Pay the taxes from money in savings or money you take out of Roth IRA.
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JoMoney
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Re: Using Roth IRA contributions in early retirement

Post by JoMoney »

Merry wrote: Sun Oct 17, 2021 9:20 pm... That’s how we’re leaning but wondering if there’s anyone out there that would argue the 72T Sepp is best for our situation...
I'm not in favor of using 72T SEPP over creating Roth IRA conversion ladder rungs for early withdrawal.
For the sake of some argument points though...

If you didn't/don't have contributions, conversions, or taxable money to seed the first 5 years of withdrawals it may make a SEPP look more appealing (but the inflexibility of the SEPP over a very long period of time if withdrawals begin early enough might still make me consider a Roth conversion ladder even against paying some penalties in the earlier parts - I'd rather pay a few penalties early on then bust a SEPP in later years and having retroactive penalties applied to the entire amounts in past years of distributions)

The SEPP would keep more money in a traditional IRA, and in some states traditional IRA's have judgement protections Roth IRA's do not (varies by state.) So if judgement protections is a concern, you might look at your specific states judgement exemptions.... but also note that there are federal exemptions IF one files for bankruptcy that may exempt some amounts of either Roth or Traditional IRAs in any state, while rollovers from workplace plans (like 401k, TSP, etc..) may have unlimited exemption amounts, and the workplace plans themselves may be immune to non-divorce related judgements even outside of bankruptcy.
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aristotelian
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Re: Using Roth IRA contributions in early retirement

Post by aristotelian »

If you can make Roth conversion ladder work, that would be preferable to SEPP. SEPP is very rigid with harsh penalties if you need to make a change.
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SailorManDan
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Re: Using Roth IRA contributions in early retirement

Post by SailorManDan »

we are seriously considering a $200k sailboat
Since this wasn’t addressed earlier – go for it and purchase the sailboat when you are ready! I did and wouldn’t change a thing. The cash sale from your 2nd house could easily fund the purchase plus additional monies converted from any Roth ladders (depending on years to retire). I retired at age 45 and sold everything, purchased a Lagoon 380 and never looked back. I retired with less net worth than you so it can be easily done. PM me if you want to discuss the sailing dream further.
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