FIRE for Shell Employees, Part 3

FIRE for Shell Employees, Part 3 walks you through the Roth conversion ladder, an advanced strategy for withdrawing money from your 401(k) early and penalty-free. Click here to watch FIRE for Shell Employees, Part 1 and FIRE for Shell Employees, Part 2.

Full Transcript:

In my previous video, I explained how withdrawals from the various buckets of money are taxed and penalized during early retirement. Today, I’m going to illustrate a strategy used to get money out of your pre-tax 401(k) early and penalty-free.

For most Shell employees, their pre-tax 401(k) is their largest bucket. It’s where you started saving first, and it’s also where company contributions go. In my last video, I explained how early withdrawals from your 401(k) are hit with income tax and a 10% penalty. Instead, I suggested you consider withdrawals from your Roth IRA, where you can pull out your contributions, and your conversions that are greater than five years old, penalty and tax free. However, what happens if your Roth IRA isn’t big enough to support the many years of withdrawals throughout your early retirement? That’s where the Roth conversion ladder comes into play.

A Roth conversion ladder is a series of Roth conversions enabling you to pull money out penalty-free after five years. A Roth conversion is a taxable event, meaning you have to pay taxes on the amount converted. By doing a Roth conversion ladder, you spread out these conversions over multiple years, keeping your taxable income lower, helping you stay in a lower tax bracket. Let’s take a look at an example of how this applies to a Shell employee to help you better understand this more advanced strategy.

Let’s assume you’re 35 years old and you want to retire early in ten years at the age of 45. As you’ve watched the previous videos, you know the importance of doing back door and mega back door Roth IRAs. Let’s assume you start doing this this year, maxing them out at $16,000 per year. You will see that you cannot access the money until after five years as these are considered a conversion. In this case, at age 40. Now, if you do this for the next ten years, you will have put $160,000 into your Roth IRA.

Now you’re retired at age 45, and you want to start pulling money out. Let’s assume that you want to pull out $30,000 per year, and then you also want to increase that each year by $1,000 to maintain your purchasing power against inflation. By doing this, you will see that you will quickly run out of money that you can pull out tax and penalty free. In this case, it’s at age 50. By starting Roth conversions from your 401(k) at your first year of retirement, you can solve this problem.

By looking ahead five years, you know, you want to convert $35,000, and you also want to continue doing that each year, increasing it by $1,000. By doing ten years of conversions, you now have the amount available to withdraw throughout your entire early retirement. You don’t have to continue doing this all the way up until age 60, as these are looking ahead five years. Once you hit age 59 and a half, you can pull money directly out of your 401(k) penalty-free.

Now, another great part about your Roth IRA is this money is invested the entire time. We’re going to assume that it’s making 8% per year. So you’ve put in $555,000, and you’ve also withdrawn 100% of that $555,000. However, because it is growing, you still have over a half-million dollars in your Roth IRA that you can pull out tax and penalty free.

This video concludes my series on FIRE for Shell employees. If you found these videos helpful, please share them with your coworkers.