Should I Roth or Should I Go?

Roth IRA Versus Taxable Brokerage to Fund Early Retirement

by FI Designer

The purpose of this post is to compare the advantages of the following two savings options to fund our living expenses for the first 5 years of early retirement using the Roth Conversion Ladder. (More on the Roth Conversion Ladder later)

  • Option 1: Continue maxing out two Roth IRAs and put any surplus savings into a taxable brokerage.
  • Option 2: Stop contributing to Roth IRAs and go all-in on a taxable brokerage.

This post is specific to our personal situation but I hope that the thought process can be valuable to others in a similar situation.

Here is information on our personal situation at the close of 2022. I hope you like bullet points as much as I do!

  • Single-income family with a husband, wife, and 2 kids ages 8 & 5.
  • Projected to reach Financial Independence (FI) within the next +/- 5 years.
  • Planning to use the Roth Conversion Ladder to fund early retirement for +/- 10 years until age 59 1/2.
  • Our oldest child may be entering college 2 years or more after we reach FI.
  • Presently maxing out one traditional 401k and two Roth IRAs (no HSA).
  • Additional savings is going into a taxable brokerage account.

We define Financial Independence (FI) as the point at which the value of our savings/investments equal 25 times our annual expenses. This corresponds to a 4% withdrawal rate. We will likely keep working after we reach 25x to pad our numbers a bit.

Roth Conversion Ladder
As stated above we plan to utilize a Roth Conversion Ladder to access our retirement accounts penalty-free before the regular retirement age of 59 1/2. I am standing on the shoulders of giants when I discuss the Roth Conversion Ladder. If you are not already familiar with the concept please see the Mad Fientist blog post How to Access Retirement Funds Early, but here is a brief summary as it relates to our situation. First, when I leave my W2 employer we will move our pre-tax 401k funds into a Traditional IRA. Second, we will start converting funds from our Traditional IRA to Roth IRA which is a taxable event. Because our taxable income will drop significantly after W2 employment, each year we will convert at least 1 year’s worth of future living expenses (increased for inflation). Third, those converted funds must season for 5 years in the Roth IRA account before they are classified as “Contributions”. Finally, the seasoned contributions can be withdrawn from the Roth IRA account penalty-free before age 59 1/2.

Roth Conversion Ladder infographic from the Mad Fientist

Our Current Dilemma
The question I am pondering in this post is how best to fund the initial 5 years of early retirement before the first year’s Roth IRA conversions have seasoned. The FI community generally recommends funding early retirement through a regular taxable brokerage account. But we have 2 children who may be entering college after we reach FI and the oldest child may be applying for financial aid when we are within the first 5 years of the Roth Conversion Ladder. I have not fully researched the FAFSA implications yet but I fear that having too much in our taxable brokerage account will hurt their chances for student financial aid. The FAFSA looks at tax information from the two prior years to the year in which the student is applying for financial aid. This is sometimes called the “Prior-Prior Year”. My current theory is that it would be more advantageous for the FAFSA to have funds in a Roth IRA than a taxable brokerage account.

Current Savings Account Balances
We define savings for early retirement as any funds available penalty-free before age 59 1/2. That includes our taxable brokerage account as well as Roth IRA contributions. The present breakdown (close of 2022) of our funds available for the initial 5 years of early retirement is as follows and presented graphically in Figure 1.

  • 55% from Roth Contributions.
  • 45% from Taxable Brokerage.

For simplicity, I have omitted online savings. We are forecasted to reach our FI number at approximately the same time that we have 5 years of expenses in savings.

Figure 1 – Our present savings breakdown.

Irrational Feelings
I personally have an irrational aversion to utilizing our Roth IRA contributions to fund early retirement versus drawing down on a taxable brokerage account. It feels like we are cannibalizing our Roth accounts which are generally thought of as the best accounts to save for the very end of retirement because the gains are tax-free, they are not subject to Requirement Minimum Distributions (RMDs), and they have favorable inheritance treatment. The logical side of my brain knows that we are not cannibalizing the account because the Roth Conversions are replenishing the funds we are withdrawing. In fact, our plan is to gradually convert nearly all of our pre-tax funds over our FI lifetime into the Roth IRA to minimize our future RMDs.

Withdrawing Roth IRA Contributions
As stated above we may use our Roth IRA contributions to partially fund early retirement before age 59 1/2. We will likely deplete our taxable brokerage first before tapping into the Roth because of the FAFSA reasons noted above. The Investopedia article titled How To Use Your Roth IRA as an Emergency Fund does an excellent job outlining considerations when withdrawing contributions from a Roth IRA.
Here are my key takeaways from the article that apply to our situation.

  1. Roth withdrawals are made on a first-in, first-out (FIFO) basis. So any withdrawals are initially classified as coming from contributions. Earnings aren’t considered touched until a sum equal to all the contributions you have made has been reached.
  2. The part of your Roth IRA contribution earmarked as your emergency fund does not belong in stocks, bonds, or mutual funds like a typical retirement contribution. It belongs in a liquid account (meaning cash or something that can easily be converted to cash and that earns interest) that can be withdrawn from at a moment’s notice without losing principal.

Market Volatility
The balance in a taxable brokerage account fluctuates up and down with the market. The same is true for a Roth IRA but the sum of your contributions in a Roth account will not fluctuate with the market. In other words, if you contribute $6,000/yr for 5 years into a Roth IRA you would have $30,000 of tax and penalty-free contributions to withdraw from. This information may be of little use to us because we would not want to sell equities in a Roth IRA when the market is down.
Disclaimer: This is my understanding and did not come from a credible source.

Preparing for FI
We have yet to fully develop a drawdown strategy but when we reach FI we will likely want a few years’ worth of living expenses in cash, not equities. To achieve this we will likely need to sell investments near retirement. Selling investments will be a taxable event within the taxable brokerage account but not within the Roth IRA. Furthermore, we will likely be in our highest tax bracket in the years leading up to FI which means we may not be in the zero capital gains tax bracket.

Analysis Results
The following are our analysis results using the Accumulator spreadsheet available for free download from Designing FI. These results are a snapshot of what our savings and FI projections look like at the end of 2022.

  • Metric 1: How long until we will have 5 years of taxable savings or Roth contributions needed to execute the Roth Conversion Ladder?
    • The analysis showed that we will reach our goal approximately 2 months sooner by halting Roth contributions and going all-in on the taxable brokerage.
  • Metric 2: What will be the breakdown of our account balances when we reach FI as a percentage of total savings?
    • The analysis results for this metric, the breakdown of account balances, are shown in Figure 2 below.

Figure 2 – Projected breakdown of our account balances when we reach FI as a percentage of total savings.

We chose Option 1, to continue maxing out both of our Roth IRA accounts in addition to funding the taxable brokerage for the following reasons.

  • There is a negligible difference in time until we reach our FI goal of having 5 years of living expenses in savings needed for the Roth Conversion Ladder.
  • Having more of our savings in Roth contributions may result in less taxation when selling if we are not in the zero capital gains tax bracket.
  • Having more of our savings in Roth contributions may result in more favorable treatment on the FAFSA.

Additionally, if our life situation changes and we are not able to reach FI by the time our kids go to college we believe Option 1 will still be more desirable.

What About a Traditional IRA?
We likely do not want to use a traditional IRA in lieu of a Roth IRA to save on taxes today because we have chosen Option 1 and plan to use the Roth IRA contributions to fund our initial 5 years of living expenses in early retirement. If we had chosen Option 2 I suppose there could be a sound argument for using a Traditional IRA but we would not have access to the funds during the first 5 years of the Roth Conversion Ladder.

Reasons to Reassess
Of course, we reserve the right to change our minds if new information presents itself. I imagine we would revisit this topic if our income drastically increases. In that case, we may not be eligible for the Roth IRA. Presently we have sufficient headroom in the 12% tax bracket for our single-income family that has 2 children qualifying for the child tax credit.

Call to Action
Please don’t stop here. Consider if some of this information applies to you. And if you have any input or ideas that may apply to this topic I would love to hear about it.


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