Admittedly, I’ve been complacent writing blog posts. I had a work trip and then a friends 30th birthday that consumed my last couple of weekends. But, I plan to get back in my normal routine of weekly posts and attempting to get ahead on writing. A huge shout out to some of my readers that asked if everything is OK because I hadn’t posted in awhile!

This week’s post was inspired by a question I received on my Facebook page:

When people talk about FIRE and the 4% withdrawal rate, are they including retirement savings? How is the fact that those savings aren’t accessible until you’re ~60yrs old taken into account, and what does that mean for your non-retirement account savings? For instance, if you spend 24k a year, your target savings is 600k – what should be the breakdown of that with regards to retirement vs. non-retirement funds if you are 29 years old and have to live off something for many years before you have access to retirement funds?

There is quite a bit to unpack here and I will do my best to deconstruct my take on this. Throughout the post, I will cite some sources that have a wealth of experience on this topic.

Do folks in the FIRE community include retirement savings when discussing the 4% rule?


The main source of the FIRE community’s assets are in retirement vehicles: 401(k)s, Roth or Traditional IRAs, and you could lump a taxable/brokerage account into this group as well. The last investment/retirement vehicle I mentioned, the taxable account, is vital to the success for people aiming to achieve FIRE. I’ll get more into the taxable account later in this post.

One of the main reasons the FIRE folks use retirement vehicles is due to their tax advantages. For a traditional 401(k), a person can deduct $18k per year. Tack on a Traditional IRA and a Health Savings Account (HSA), a person could deduct $30,250. Some jobs that offer a 401(k) and 403(b) enable a person to tack an additional $18k on top of that – check out this couple over at Millionaire Educator to see how they accomplish this feat.

The more that you can save into tax-advantaged accounts, the less Uncle Sam will take out of your pocket. How much? Let’s look at a quick example of a person making $100k and compare how much they pay in taxes if they don’t save anything versus if they maxed out their 401(k), IRA, and HSA.

Federal tax liability for not saving into tax-advantaged accounts: $25,697

Federal tax liability if tax-advantaged accounts are maxed out: $15,821

Not only would you save over $30k for retirement, you would save almost $10k that goes directly into your pocket!

Strategies for paying minimal taxes and avoiding penalties 

The Roth Conversion Ladder is a well-known strategy implemented in the early retirement community. Here is how the Roth Conversion ladder works.

When you retire, you roll your 401(k) into a Traditional IRA. This is a non-taxable and penalty free event.

Next, you convert the money in your Traditional IRA to your Roth IRA. You do pay taxes on the amount you convert, but not always as I will discuss later.

The contributions you make to your Roth IRA is able to be pulled out tax-free 5 years after you first contribution.

Here is a nice flow chart the Mad Fientist put together to summarize the Roth Conversion Ladder process:

Coming back to the taxes you pay on the conversion from a Traditional IRA to a Roth IRA…

Disclaimer: I am not a tax expert so please don’t take this advice to the bank. My motto with any new information I receive is: trust, but verify. I recommend you do the same.

The lower your income is, the less you will pay in taxes when you convert your money. Additionally, there are tax deductions that you can take advantage of. Let’s say you are married: the standard deduction for a married couple is just under $13k, you and your spouse each get a personal exemption of $4k. Therefore, you can deduct almost $21k.

So, if your income for one year is $0, you can essentially convert $21k from your Traditional IRA to your Roth IRA COMPLETELY TAX-FREE.

Now, if you are like me when I first heard this you are probably scratching your head saying, “this sounds great, but how am I going to live on $0 for an entire year?”


The Advantage of the Taxable Account

The taxable account is key to the Roth Conversion Ladder because it provides income during the years you are converting money from your Traditional IRA to your Roth IRA.

There are a few tax implications with a taxable account, but first, let’s take one step backward.

Before investing in a taxable account, I recommend maxing out your 401(k), HSA,  and Traditional or Roth IRA before starting a taxable account. Understandably, not everyone is able to do this. However, if you are determined to retire early, I stress that you find efficiencies in your budget to make saving this way possible.

If you are able to contribute to a taxable account, here are a few things you should know about it.

  1. Money used to contribute into a taxable account is post-tax.
  2. Growth on your investments is taxed at long-term capital gains – which is 15% or less if you make under $400k
  3. The money is easily accessible and can be withdrawn penalty-free after one year of investing.
  4. I recommend investing in Vanguard or Fidelity’s low-cost index funds.

One of my favorite bloggers, Physician on Fire,(PoF), has two articles I recommend checking out to learn more about the taxable account. First, is an interview PoF featured on his site from a fellow Dr. that discusses the Advantages of a Taxable Investing Account. The second article is a great resource for DIY Investing, and step 12 reviews the taxable account.

So taking the example from the question on Facebook:

A married person who had annual expenses of $24k/ year needs a portfolio of $600k (25x annual expenses.) Let’s say by age 25 this person graduated from college and eliminated all of their debt. They are maxing out their 401(k), HSA, and Roth IRA (total of $30,250/year) AND they are contributing $5,000/year to their taxable account.

By the time this person is 40, they will have just over $950k (assuming 8% return), with $135k of that in their taxable account. Implementing the Roth Conversion Ladder, this person can pull just over $24k/year from their taxable account to live on AND roll over roughly $21k a year from their Traditional IRA to their Roth IRA TAX-FREE.

AND, they are paying $0 income tax because unless you make over $75k as a married couple, you pay $0 in long term capital gains.

Once their taxable account is consumed, they can start to pull $21k/year from their Roth IRA tax-free. Any amount they withdrawal over the $21k they would have to pay income taxes and a 10% early withdrawal penalty.

There’s more…

The Roth Conversion ladder is one of two ways to access your funds early. In my next post, I will cover something that I first discovered during week one of my blog. I went to my local library and I checked out a book on personal finance. I’m ashamed to admit that I cannot remember the name of the book, but I do remember one of the strategies: Substantially Equal Periodic Payment (SEPP). Stay tuned as I unpack the details for how SEPP works.

Do you plan to implement the Roth Conversion Ladder in early retirement?