“Isn’t a Roth conversion ladder far superior to an SEPP in every way?”
“You wrote all of this stuff about SEPPs but it is a complete waste of time, everyone should just do a Roth conversion ladder.”
“Thanks for the SEPP Calculator but isn’t a Roth conversion ladder more flexible?”
All good questions / comments, of course. The Roth conversion ladder is a great option to access retirement accounts before age 59.5. But some people will still find that the SEPP is better suited to their wants / needs.
Me, for example.
Roth Conversion Ladder vs SEPP, Which is Better?
The Roth conversion ladder and SEPP are two options for accessing retirement account funds before age 59.5.
The Internet has largely decided that between the two, the Roth conversion ladder is the right choice. And it is a good choice, certainly.
Unless of course you don’t have (or don’t want to tap) 5 years’ worth of expenses in easily accessible form.
Let’s explore.
Roth conversion ladder option
I turn 50 this year (2024.)
If I want to spend $29,200 per year (the 2024 standard deduction for MFJ) from retirement accounts starting as soon as possible, I can do a Roth conversion of that amount in 2024. After the conversion has seasoned for 5 years (2029), I can make a tax-free / penalty free withdrawal to spend as I wish.
I just do this every year for the next 5 years to get me to age 59.5.
Now I just need sufficient funds to get through the first 5-year seasoning, or $29,200 * 5 = $146,000.
If you have the $150k in taxable accounts, this is easy and obvious, right?
Well…
I haven’t had a paycheck in over 12 years now and have been living pretty well that entire time, which means my taxable account hasn’t had any recent additions.
Here is a stock purchase I made back in 2008
Clearly I have the $150k available, but for better or worse those funds have grown quite a bit (from ~$200k to ~$800k)
If I sell $29,200 worth of these shares to fund current expenses I will realize a capital gain of ~$22,000 (details in the post: Long Term Long-Term Capital Gains.) Adding this to the $29,200 annual Roth conversion will throw a bit of a wrench into our low-tax lifestyle.
Unless…
SEPP option
What if I can skip the whole 5-year seasoning period and go straight to spending funds directly from my retirement accounts?
SEPP to the rescue.
Simply by agreeing to withdraw an equal amount each year (e.g. $29,200) I can pull funds directly from retirement account with no seasoning period, allowing me to leave the shares in my taxable account untouched.
Since I have no plans to commit at least 40 hours a week to earning money for someone else and I am reasonably close to age 59.5, obligating myself to annual withdrawals for the next few years seems a reasonable risk.
What happens to taxable account long term?
If I don’t sell shares to live today, and selling them at any time will result in a large realized gain, do I just… hold them forever?
Yes, that’s right.
When their parents die our kids will get those shares, but with stepped-up basis.
One of the weirdest parts of the US tax code is that all assets get stepped up in basis upon death, meaning if my 2008 stock purchase grows to $10 million… our kids can sell that $10 million worth of shares with $0 in taxable gains.
Point being – once shares grow significantly, the incentives are to never sell… which is why the uber rich will often borrow against assets instead (see: Sweet, Sweet, Debt.)
Related:
Multi-Generational Tax Minimization
My Actual Plan
My actual plan is still a bit in flux… I have another year or two of high(er)-basis stock I can tap. I may be able to make some very small capital gain harvests (even $1,000 helps) to delay things a bit… but some time in the next year or three or five I will (highly) likely start an SEPP with a withdrawal designed to fill the standard deduction / 0% tax space.
Should I find during my annual December tax review that we still have some (small) opportunity for zero or low tax Roth conversions, those can be done in addition.
Hopefully that is caveated enough ;)
Summary
The Internet has largely decided that a Roth conversion ladder is the one and only approved way to enable early withdrawal from retirement accounts.
The Internet can make its own retirement plans, but we will likely start an SEPP in the next few years. What is the difference really between starting withdrawals at 59.5 vs 54.5?
This will allow immediate spending from retirement accounts in a tax-friendly way, with minimal risk or obligation, meanwhile reducing the need to spend from very low basis taxable accounts.
There may be other scenarios in which an SEPP would be the better choice (vs Roth conversion ladder.) Analysis of these situations is an exercise left to the reader.
Related:
IRA Withdrawals Before Age 59.5
SEPP Calculator
Thanks for this idea, it may work for me too. Have you looked into impact of having larger taxable accounts on college financial aid calculations for when your kids are older? I imagine you’ve already figured a way to minimize any implications.
I think for the sums involved that it won’t make much difference for FAFSA purposes… single digit percentages.
But I do have a now somewhat reasonably sized HSA and receipts for IVF and childbirth for 2 kids.
See: Hacking the Health Savings Account (HSA) for College
Quick question, what are your annual insurance premiums?
The reason that I ask is that the IRS also says you can make penalty free health insurance premium payments penalty free from some retirement accounts if you are unemployed. (retired?)
About $100/month only
Great work on keeping those premiums low. I have read many a Bogel Head post where taxable income is high, premiums are high, rent is high, etc. Good to be on here with my people.
I think a SEPP is a superior option for most, but as you’ve mentioned the internet just decided that the Roth conversion ladder is better without running any of the numbers. SEPP wasn’t as good of an option when one was stuck with low interest rates, but since they’ve increased the minimum interest rate to 5% a SEPP is a much more attractive option. Some will argue that they don’t want to withdrawal from their pretax accounts yet, but they’ll eventually have to to avoid massive RMDs in the future. Additionally, the SEPP is more tax efficient.
Why do you say the SEPP is more tax efficient? Same reason that I mentioned or something else?
You touched on some of the reasons, but there are even more reasons why a SEPP is more tax efficient for your typical early retiree.
For example, if one uses a Roth conversion ladder, they need to save enough in their brokerage account to cover both living expenses and taxes for the Roth conversions during the first five years. Assuming the Roth conversion ladder is the primary source to cover living expenses, this requirement means accumulating a substantial amount in a brokerage account, which is inefficient compared to saving in tax-advantaged accounts like a 401(k), Roth IRA, or HSA.
Moreover, in Year 6 of the Roth conversion ladder you can only withdraw the Roth conversion basis, not the earnings. This means you pay taxes in Year 1 for money you can’t withdraw until Year 6, and you cannot access any earnings (until age 60). This inefficiency only worsens when considering inflation and potentially higher withdrawal amounts/tax rates.
This is a really cool! I’ve been worried about having a crazy tax rate on retirement accounts or huge RMDs. We have carry over IRAs so conversion is probably not an option. So you can take your SEPP to fill the 0% then take taxable at 15% on gains(plus unintentional dividends) for the rest of your needs?
You can size the SEPP to your needs – I’d likely set it equal to the standard deduction. Then most/all qualified dividends still taxed at 0%
What is a carry over IRA? Rollover from old work 401k? Those can be converted.
My wife and I had simple IRAs and 401ks from self employment and previous employers respectively. We rolled them into a traditional IRA 10+ years ago. They make up about 20% of our current retirement savings. I’ll have to reread the previous articles on the conversion. Thanks!
You mentioned Qualified dividends. I was going to bring that up as I have to read what a SEPP is.
So between the standard deduction and qualified dividends and capital gains you can have about $108,000 in tax free income.
But let’s take your case where your writing income may wipe out your standard deduction.
So you have $84,000 + – that can come from capital gains tax free. But then you get to add the cost basis to that also.
So I don’t know why it wouldn’t pay to spend down the taxable account.
State taxes and ACA premiums
So is the reason the SEPP is more efficient to use because you are taking money out of an account now that is taxed at the ordinary income tax rate instead of letting it grow and allowing the taxable account to grow which will only be taxed at the capital gains rate ?
Thanks for putting together a SEPP calculator.
The output shows $469K as an initial IRA value for $29.5K Target income (5% interest) at 54.5 age. Does that look right? Do you have to move this large amount to be able to withdrawal only $29.5K?
After the 5 years of $29.5K withdrawals, there’s significant amount of IRA balance left. Can you then do Roth conversions on the remaining amount or are you stuck with the $29.5K annual withdrawal on this SEPP account?
>Do you have to move this large amount to be able to withdrawal only $29.5K?
Yes
After 5 years (or age 59.5, whichever comes later) you can do whatever you want – roth conversions, withdrawals of any size, withdraw nothing until age 72, etc…
My wife and I are 70 so we are staring down the barrel of a different problem, namely RMDs a couple of years down the road. Never had the opportunity to do SEPP withdrawals since I was a fairly high earner until retiring at 60, and the taxes I would have owed never made sense anyways. The same with Roth conversions over the years as well, and even moreso now. Starting to take some monies out of retirement accounts each year but it will not be enough to make a significant difference in the taxes we will be eventually on the hook for with the RMD wall we are barreling towards.
That being said, my recommendation is to absolutely do the SEPP route at this stage of your life and the circumstances you and your family find yourselves in. Your taxes will be minimal, and you’ll have to choice of spending it or reinvesting the proceeds. Whatever route you ultimately take, best wishes.
Mr. ChuckY, Any serious ideas about how to mitigate taxes on RMDs?
Steve, I am doing some research now on some options, none of which appear great at this time. Most “experts” give advice like give your money to charity for the writeoff. While that’s fine for some, giving up 100% of my money to get a tax writeup of 20+% isn’t what most people are looking for with their retirement funds, noble as that gesture may be. And while I am dead set against annuities, there may be one that has some interest, but as I said I need to do more research.
Steve, I am doing some research now on some options, none of which appear great at this time. Most “experts” give advice like give your money to charity for the writeoff. While that’s fine for some, giving up 100% of my money to get a tax writeup of 20+% isn’t what most people are looking for with their retirement funds, noble as that gesture may be. And while I am dead set against annuities, there may be one that has some interest, but as I said I need to do more research.
Thank you for the kind reply and like you donations are not my first choice. I am currently retired and using annuities to defer income that I don’t need. My initial thoughts are to in the future off-set RMD income by going back to work or starting a business from home and then contributing excess income back to IRA, 401k, HRA etc. where possible.
I believe the answer to what you can do to avoid / reduce taxes on RMDs is… nothing. Nada.
Once your IRA gets big enough the knobs we can tweak just don’t have a big impact, like trying to turn around the Titanic manually with an oar.
Sure, we can do big Roth conversions… for example, with no other income we could convert $230,000 to fill the 22% tax bracket (2024, MFJ.) All that does for us though is save us from paying 22% next year and maybe a little bit at 24% the year after that. It is hard for me to get excited about reducing the marginal rate by 2%.
Jeremy you are probably right about doing nothing. I need to find something else to spend my time on. These are first world problems for sure.
So, if you do a Roth conversion, does that count as your RMD? At least if you did that the future earnings would be tax free. Seems like it might be worthwhile.
A Roth conversion does not count as your RMD
Love the creative thinking on this. We might do something similar. I’m about one year older than you. So on the same timeline. I have a fair amount of high basis taxable though — to carry us for a few more years.
And if you do follow through on the SEPP, if you would be willing to write up the nitty gritty steps in a post, many of us would be grateful. As you noted yourself elsewhere, this is not a move one wants to screw up…..
I also had a fair amount of high basis shares in taxable but I traded them for a house.
In hindsight I should have gotten a mortgage 3x bigger as borrowing at a rate less than inflation is nice.
In your situation the RCL is a good choice.
GCC, what makes you say, “In your situation the RCL is a good choice?”
The RCL is the most flexible and lowest risk. No commitment.
Since you have easily accessible high-basis stock, just use that to fund current expenses.
It’s only when there is no convenient or tax-friendly spending money available that the SEPP helps (due to immediate access to retirement funds.)
Got it. Tx, Jer.
Me and my husband, 50 and 55, have been doing SEPPs for 2 years now. Love them.
This year, at the age of 52, I began a SEPP plan. I’m using the proceeds to fund contributions to my wife’s and my Roth IRAs, our HSA, and our brokerage accounts, and I plan to continue doing so for the next eight years.
I agree that SEPP is often viewed as a last resort or heavily criticized. I share your perspective on its use.
You also have earned income? (Only earned income can be contributed to Roth IRAs)
Yes. I downshifted my income into something a lot less stressful. I was a super-saver and this has been a good bridge to shift money out of pre-tax, transition out of a super-saver mindset and yet still save.
Very timely post, as we’ve been planning for early retirement now for years and now we are finally within 6 months of lifting the escape hatch! I would suggest the 72tnet.com website as a resource as well for anyone interested in this topic. It seems like the laws change on this frequently, for example I believe there was a major change in 2022, but I am not sure what it was, only that once you use this strategy, as you’ve already mentioned, it’s a set it and forget it, no changes allowed. I think it was initially a scary option, thinking about making a mistake during withdrawals and paying a penalty, but I’m no longer afraid, as I look at this next chapter of life as what can I do now to avoid having too much later and paying RMDs, again, you asked about this above.
Balancing the now with the later, that is the goal… Keep up the good articles, you’re making me think!! ;)
We are still contemplating. In our case the 5 year or 59.5 are basically the same. I like the idea SEPP up to the standard deduction.
I recently learned that pulling Roth basis counts as income for FAFSA. This is a major downside for folks using Roth conversion ladder that have kids in college and would favor using SEPP as an alternative way to get income before 59 1/2 and not have it double counted for college contributions
SEPP isn’t income for FAFSA?
I think SEPP is a great option for early retirees over 50 years old. The timeline works out better. I’m also 50 and I’m starting to think RMD will become a problem for us.
Good point about the step-up basis for the taxable account too. That’s a good way to save on taxes if you plan on building an inheritance.
Sorry I might be missing some obvious strategy concepts. The SEPP is new territory for me. How do you benefit from a SEPP vs Roth conversion other than filling in the 5-year seasoning gap?
It seems to me like you could roll the same amount from an IRA to a Roth to use up a standard deduction? (Assuming you don’t need the funds in the next 5 years.) Once seasoned in a Roth you would have access to those funds tax free for the rest of your life.
At that point your children would also inherit a Roth and not a taxable account even with a step up in basis. Wouldn’t the Roth be a more valuable account to inherit simply because it would be tax-free into there future as well?
For those of us that don’t want to pay RMDs, I’ve been looking at doing larger Roth rollovers going forward. For the past 5 years I have rolled over as much as possible while still maintaining close to a $0 tax bill every year. But I’m considering filling up the the lower tax brackets going forward to avoid larger RMDs in the future. I’m 47 currently.
A little background, I own some rental properties, and have been able to take advantage of depreciation and other factors. Once my rental properties are paid off and I’ve used up all the depreciation at the 27.5 year mark, my ability to depreciate larger amounts goes away. Like many, I expect my income to be higher later than now. Because of this I need to move as much now as possible. Even though RMDs don’t kick in until 73, it’s best to start as early as possible with a strategy to avoid them.
Jeremy seems to have no problem with funding the next 5 years. And taxes are the same coming out of a traditional IRA whether the funds go into a taxable account or a Roth, so I don’t see the tax benefits one way or the other from that standpoint.
Please, anyone with a better grasp than I, explain to me how moving funds via SEPP from an IRA to a taxable account, rather than a Roth might be preferable? I just don’t see how it’s a benefit other than filling in the 5-year gap.
>I just don’t see how it’s a benefit other than filling in the 5-year gap.
Isn’t that enough?
>Jeremy seems to have no problem with funding the next 5 years. And taxes are the same coming out of a traditional IRA whether the funds go into a taxable account or a Roth, so I don’t see the tax benefits one way or the other from that standpoint.
Taxes are NOT the same. If the funds go into the Roth, I also need $ to pay this years’ expenses. That means selling highly appreciated assets.
Correct me if I’m wrong, but I think the big downside is that once you start a SEPP, you are stuck with those terms. If you try to adjust or stop the payments, you could end up owing retroactive penalties. I think that’s why there is hesitation in some quarters to embrace SEPPs.
Sure, it’s a commitment. Not a big one for somebody in their 50s, but one nonetheless.
Details here: IRA Withdrawals Before Age 59.5
Thank you for leading this discussion, I can see how this would help many early retirees and I envy you in being able to share these tools with other people so freely. Today I got a call from a long time friend who was asking me questions about my early retirement because she was ready. I hope you don’t mind me sharing your url?!!
Please do share, thank you, I very much appreciate it.
Great articles on SEPP! I early retired about a year ago at age 42 and after extensive “excel-sheeting” I believe my optimal withdrawal path is to perform Roth Conversions PLUS when I hit 55 do a small-ish SEPP for 5 years. This approach minimizes and evens out yearly tax bills until I reach 59.5. Is there any reason that I cannot/should not be able to do an SEPP as well as withdraw “fully seasoned” Roth IRA contributions at the same time from age 55 to 59.9? I will have completely separate accounts for the SEPP and Roth IRA Contribution withdrawals.
Nothing prohibits an SEPP and Roth withdrawals simultaneously.
Why not just continue the Roth conversions those last 5 years?
If there is also nothing prohibiting SEPP and Roth Conversions simultaneously? Then yes I will definitely evaluate doing further Roth conversions at 55-60 while doing the SEPP at 55-60. Also thanks for the response, I have found your site to be a huge inspiration for years!
That is also not prohibited (from 2 different Traditional IRAs.) Doing a Roth conversion from the SEPP IRA would violate the terms of the SEPP contract.
But why do the SEPP at all? Just continue with the Roth conversion ladder.
Maybe I’m missing something but I plan to stop doing the Roth Conversion at 54 because Roth converting at 55 and older means that the 5 yr seasoning period puts me at 60 yrs old, which is an age that I am able to withdraw penalty free from my 401k at that point.
For background, my cost of living is around 50k and I have $1.25M in savings/investments. To make my explanation a bit easier to follow I am using round numbers below, but I have a large excel sheet for every year with taxes and such worked out.
According my math it appears that its better to do scenario 1) Roth Conversions + SEPP than Scenario 2) Roth Conversions only. In scenario 1, I convert around $30k/yr from age 43-54 and then do SEPP of around $34k/yr from 55-60. This leads to a Fed + State tax bill in California of around $1800/yr from 43-60 or around $31k total.
Scenario 2 of just doing the Roth Conversions of around $42k/yr from age 43 to 54 leads to Fed + State tax bill of around $5k/yr from 43 to 54 and $0 tax from 55-60 so total of $55k in taxes. In scenario 1 I Roth convert less money because I have the SEPP waiting to kick in at 55 and also in scenario 1 Im paying lower taxes for my first 10 yrs of retirement. In scenario 2 I need to Roth convert a larger amount per year in order to fill the gap from 55-60.
Maybe this difference in the two scenarios is not large enough to justify the trouble of doing the SEPP? Or maybe you see some flaw in my logic? Thanks again!
Basically you plan to spend $550k+/- between now and age 59.5, but because of the 5-year delay with Roth conversions you would need to front load some extra to cover spending from 55-60. Appending an SEPP at the end of the train lets you spread the withdrawals over a longer time frame. Do I got that right? (Smart use of both withdrawal tools.)
I think the only thing I would append to this, solely as a thought experiment, is that maybe looking at $31k vs $50k tax is not the best comparison, as you have to also pay taxes after 59.5.
In both scenarios you are choosing to pay tax at a marginal rate of 12% Federal. Once you decide to pay at 12% on a Roth conversion, it is mathematically equivalent to paying 12% in the future (associative property of multiplication.) In practice this means it can make sense to just fill the 12% tax bracket completely rather than withdraw the minimum calculated (filling 12% federal tax bracket would equate to ~$60k federal / single filer / 2024.)
So in your spreadsheet if at age 80+/- the RMD starts to have you pay 22%+ then doing more at 12% along the way would be prudent.
Where this would bite you is with ACA premium subsidies plus an extra 2%+/- on California taxes… which happens to be about 10% total, so maybe it is the same either way.
(But can do the The Obamacare Tick-Tock.)
Similarly, it wouldn’t make sense to pay $0 tax from 55-60 in your Scenario 2. You would want to at least Roth convert up to the standard deduction but maybe to the top of the 10% or 12% brackets. That 0% tax space is valuable, and those post 55 Roth conversions season automatically at age 59.5 (no 5-year delay, see Kitces with links to IRS regs.)
Yes your summary of my situation is correct and I am filing taxes as single. You bring up some good points that I had not thought about around the fact that I am already planning to pay at the federal marginal rate of 12%. I will start fleshing out these excel sheet thought experiments that you recommended (fill the 12% tax bracket completely, etc) and see how this plays out around RMD, healthcare costs, etc. I also did not realize that Roth conversions season automatically at 59.5. And yes I will not pay $0 at 55-60 in Scenario 2, since I can Roth convert during those years. I also like that Obamacare tick-tock article, somehow I missed that one! I had actually previously looked into a possible Obamacare/Medi-Cal “tick-tock” to save on healthcare. Haha! Wow, LOTS to unpack here and see how each plays out in my excel thought experiments. Thanks so much and keep up the great writing!
May want to consider front loading Roth conversions in 2024-25 to maximize 12% bracket while it’s available. This bracket will be eliminated when parts of the 2017 TCJA sunset at the end of 2025, unless congress acts.
I am 43 and have $1.5M in a Roth IRA, $900K in a pre-tax 401K, and only $400K in taxable. I’m wondering if I’m out of luck tapping into the Roth funds since it’s almost all earnings (although I did contribute the max per year from 2006-2023, but it’s mostly earnings from Tech Stocks and Bitcoin ETFs (including GBTC back in the day). SEPP only works on IRAs and pre-tax 401Ks, right? Seems there’s no loophole to get at Roth Earnings before 59.5? I’ll probably have 3-4x that amount by age 59 but I need money now….
You can do a SEPP on a Roth if you need to access earnings.
However… an SEPP eliminates the 10% early withdrawal penalty only. Earnings distributions before age 59.5 would still be taxable income, so equivalent to making similar withdrawals from a Traditional IRA.
Got it. Suppose In a year or so those numbers are more like $3M in a Roth IRA, consisting almost all of earnings, and I’m 44 now. What I really want/need to do is use some of that for a down payment on a mortgage or maybe even buy a home outright in a very high-cost of living area. I was thinking my best bet, if I can’t actually touch the earnings, might be to get an asset depletion mortgage with them counting the retirement accounts 50%. I do anticipate about half of my taxable account also going up exponentially, but I like having a few years of living expenses liquid in it.
If your accounts are going up exponentially you could just rent forever. Why trade high growth for low growth?
If you prefer home ownership (as a luxury purchase) then you could pay a bunch of tax as a one-time expense if you decide to purchase outright, no big deal. Borrowing money (mortgage) will allow you to spread that expense over time for a fee (interest.) In either case, paying a 10% early withdrawal penalty is only 1/10th of your projected 1-year growth and is the most flexible option. In all cases, taxes/penalties/interest are small relative expenses. There is an exemption to the 10% penalty on a $10k withdrawal for first-time homebuyers.
Have you done much modeling to compare the two scenarios?
For example: Age on the Horizontal Axis, Net Worth on the Vertical.
Scenario 1: Roth Conversion.
Scenario 2: SEPP
Another vertical axis option that would be interesting would be liquid net worth
Which ends up better is going to vary based on the situation. In our case we will end up doing both because there are advantages of each at different times – roth conversion better at young age when have lots of cash in brokerage account and high basis, SEPP better at later age when have less cash/high basis stock and the 5 year Roth conversion delay makes it impractical (e.g. at age 55.)
Can you do Roth conversions while receiving SEPP. My (50f) situation was because of illiquid funds in a TIAA account. So when I retired early I used the TIAA traditional illiquid funds and took an annuity using 72t. It was about a third of my 403b. Now I have the other two thirds that I would like to start converting into a Roth. Is there any issue with that, I can’t find a definitive answer? Thanks.
Generally speaking, an SEPP is setup on a qualified plan. Once you start an SEPP on that qualified plan you cannot change anything without large penalties.
What people do, in advance, is split their qualified plan into 2 or more separate / distinct plans, e.g. rollover their 401k into 2 or more IRAs. Then you can establish an SEPP on IRA1 and do Roth conversions on IRA2. In this case IRA1 is untouchable beyond the SEPP withdrawals.