Retire from 8 to 5 

So we are in a different situation than a lot of people with 401ks – we do not live in USA but have sizeable 401k and we do not want to be a millionaire when we are in our 60s and be forced to loose a lot of money with required minimum distributions. We would rather withdraw, at a consistent lower rate, and use the money to fund our early retirement. For this, we are adopting a strategy of building a Roth conversion ladder. This strategy could work for you, if you live in the USA, quit your full-time job and do not have a significant taxable income source. You could do this temporarily, say during a 2year career break, and contribute to your 401k after you return to a full-time job. Every circumstance is unique, and it will be good to work out the math on your situation.

For our situation, per form 1040NR Graduated Tax Rates on Effectively Connected Ordinary Income for 2022: (marginally changed for 2023 and 2024, but close enough for this scenario here)
– 10% on your taxable income from 0 to $10,275
– 12% on your taxable income from $10,275 to $41,775.
– 22% on your taxable income from $41,775 to $89,075.
– 24% on your taxable income from $89,075 to $170,050

If we wanted to pay minimum tax (10%), we would be limited to an annual $10,275 conversion, and assuming 401k pot continues to grow, it will take us 20+ years to get access to our full 401k. We would like to fund our early retirements primarily through 401k, and hence need the funds to be accessible within 10years. Hence, we choose the 12% bracket, which will allow us to convert $41,775 per year. If you live in the USA, and have a taxable income source or not, your brackets will be different.

Let’s look at how this would work using the table below. If you had a 401k starting pot of $200,000, and assumed a very conservative 5% year-over-year growth, in year 1 (2022) you would convert $41,775 into a Roth IRA, and incur $4,808 in taxes and effectively build a Roth IRA with $38,816. The principal money (excluding interest) is now available to withdraw tax-free in 2027. We are not saying you would withdraw the full $41,775 in 2027, but you could if you needed it. In this scenario, total tax paid is $25,378, and we feel its well worth it to gain the flexibility and access to quick cash without waiting until we are 60.

If you live in the USA, have a full-time job then your tax bracket to do this conversion tax-efficiently is different. However, if you do not have a full-time job (because you are on a career break, family leave or whatever reason), then this could be a good time to make a stab at converting a part of your 401k with little tax. Every situation is a bit different, and requires some math but ultimately if you like being able to access your own money, building a Roth ladder is a good strategy.