Mega Backdoor Roth vs. General Brokerage

[midweststache]

So... we're finally at the point in our savings where all our pre-tax options are THISCLOSE to being maxed. So I've been looking at opening a brokerage account for post-tax contributions.

But, because I am a strict adherent to the MMM Investment Order I wanted to do more research on what a Mega Backdoor Roth is. Lo and behold, my workplace offers both a Traditional and a Roth 403(b) option, so (as I understand it) I could continue maxing my traditional 403(b) and contribute to a Roth 403(b) using after-tax dollars, up to Traditional403b+EmployerMatch+After-TaxRoth403b=$70K.

Here's my question: what is the benefit of contributing to a Roth 403B vs. contributing to a taxable brokerage account? They're both using after-tax dollars, and in many ways the taxable brokerage offers more flexibility with withdraws. Is it just a payroll (after-tax withdraws can be automated by your employer) or paperwork (funding a Roth ladder conversion is easier when your Traditional and Roth accounts are held with the same provider) issue, or is there something I'm missing?

[Laura33]

Here's my question: what is the benefit of contributing to a Roth 403B vs. contributing to a taxable brokerage account? They're both using after-tax dollars, and in many ways the taxable brokerage offers more flexibility with withdraws.

Are you asking what's the benefit of a Roth over a taxable brokerage?  You start with after-tax dollars for both, but the Roth grows and then can be withdrawn tax-free, whereas you pay taxes on all of the growth in a taxable account, either ongoing (annual capital gains/dividends) or when you sell (capital gains). 

Or are you asking what's the benefit of a payroll Roth vs. a DIY Roth?  The payroll Roth gives you a hell of a lot more $$ you can put into a Roth, as your math shows.  Outside of a 401(k)/403(b), your ability to contribute to a tax-sheltered account (either tIRA or Roth) is very limited -- $7K total for 2024.  Your payroll mega-Roth gives you the ability to put way more aside each year to grow tax-free.

[midweststache]

@Laura33  - It was the first question - the tax benefits. You laid that out perfectly and succinctly - thank you!

[SweatingInAR]

So... we're finally at the point in our savings where all our pre-tax options are THISCLOSE to being maxed. So I've been looking at opening a brokerage account for post-tax contributions.

But, because I am a strict adherent to the MMM Investment Order I wanted to do more research on what a Mega Backdoor Roth is. Lo and behold, my workplace offers both a Traditional and a Roth 403(b) option, so (as I understand it) I could continue maxing my traditional 403(b) and contribute to a Roth 403(b) using after-tax dollars, up to Traditional403b+EmployerMatch+After-TaxRoth403b=$70K.

Here's my question: what is the benefit of contributing to a Roth 403B vs. contributing to a taxable brokerage account? They're both using after-tax dollars, and in many ways the taxable brokerage offers more flexibility with withdraws. Is it just a payroll (after-tax withdraws can be automated by your employer) or paperwork (funding a Roth ladder conversion is easier when your Traditional and Roth accounts are held with the same provider) issue, or is there something I'm missing?

Are you sure that you have access to a Mega Backdoor Roth? It is not the same as a classic "Roth" account.

At least in my Fidelity 401(k), I have three options: Pretax, Roth, and After Tax. In Fideltiy Netbenefits, it looks like the image in section 2 of this tutorial:
https://www.buckbybuck.com/how-to-set-up-a-mega-backdoor-roth-with-fidelity

I only have 401(k) experience, but I imagine that even in a 403(b) you would need the exact wording of "After-tax" and NOT "Roth". Can you find a "Mega Backdoor Roth" tutorial for your 403(b) provider?

[midweststache]

@SweatingInAR - More assumptions on my part - I just assumed that a Roth 403B would allow for after-tax contributions, since my Roth IRA is only post-tax contributions. I've sent a follow up inquiry to my benefits HR person and will probably follow up directly with my service provider to confirm whatever they tell me.

(Our HR team is great and goes to bat for a lot of strong benefits on our team, but their communication and nuance of these kind of logistics often leaves something to be desired.)

[seattlecyclone]

Roth contributions technically are "after tax" but they're not the "after-tax" contributions you're looking for with the mega backdoor. The traditional tax-deferred and Roth contributions are the two most common kinds and they both count toward a shared $23k/year limit. Then there's a third kind: traditional after-tax where the contributions are post-tax and then the growth is taxable (unlike a Roth where the growth is tax-free). These are allowed to go above the $23k/year limit and are what you need for the backdoor. Very common for plans not to offer this option.

[seattlecyclone]

As to your original question of why would you want to do a backdoor Roth instead of a non-tax-sheltered brokerage account: it's all about the different tax treatments and the tradeoffs involved.

With a standard brokerage account, if you put $10k into VTI and sell it a couple decades later for $30k to pay your bills in retirement you'll owe capital gains tax on the $20k gain. The fund also pays out dividends quarterly, which you'll be taxed on every year in the meantime.

If you put $10k into your Roth IRA through a backdoor, you pay no taxes on dividends as they come in. If your $30k withdrawal happens after you turn 59½ it's all tax-free and doesn't even count as income for purposes of ACA insurance or other things that care about your adjusted gross income. Before 59½ you can withdraw up to the $10k you originally put in without owing tax (more or less, there can be some caveats with the backdoor), but if you go beyond that you'll pay a higher rate than if you had gone with a non-tax-sheltered brokerage account. That's the trade-off.

[reeshau]

Here's my question: what is the benefit of contributing to a Roth 403B vs. contributing to a taxable brokerage account? They're both using after-tax dollars, and in many ways the taxable brokerage offers more flexibility with withdraws.

Are you asking what's the benefit of a Roth over a taxable brokerage?  You start with after-tax dollars for both, but the Roth grows and then can be withdrawn tax-free, whereas you pay taxes on all of the growth in a taxable account, either ongoing (annual capital gains/dividends) or when you sell (capital gains). 

This is true, but at least as it currently stands, long-term capital gains for MFJ is 0%, up to $89k.  Considering those are gains, not the total withdrawal, a Mustachian family can live quite well within the 0% bracket.

* of course, there are ACA implications, nonrefundable tax credits, and scores of other things to consider.

[Laura33]

Here's my question: what is the benefit of contributing to a Roth 403B vs. contributing to a taxable brokerage account? They're both using after-tax dollars, and in many ways the taxable brokerage offers more flexibility with withdraws.

Are you asking what's the benefit of a Roth over a taxable brokerage?  You start with after-tax dollars for both, but the Roth grows and then can be withdrawn tax-free, whereas you pay taxes on all of the growth in a taxable account, either ongoing (annual capital gains/dividends) or when you sell (capital gains). 

This is true, but at least as it currently stands, long-term capital gains for MFJ is 0%, up to $89k.  Considering those are gains, not the total withdrawal, a Mustachian family can live quite well within the 0% bracket.

* of course, there are ACA implications, nonrefundable tax credits, and scores of other things to consider.

Also true.  OTOH, we're talking about money that may not be needed for another 40-50 years, and who knows what tax rates will be then?  At some point, someone's going to have to pay for the various political giveaways; while I expect taxes to go down in the next 4 years, I do expect them to go up at some point afterwards (though I probably can't even begin to identify the ways that will happen).

For me, I consider the Roth as sort of a hedge against future tax changes.  I have a lot in a regular 401(k), and a lot in a standard brokerage account.  Withdrawing from both of those comes with tax consequences, so they have to be managed.  Having a Roth, OTOH, gives me another pot of money that I can withdraw from if needed in the future (e.g., to keep my taxable income below a given threshold).  So when my firm started offering a Roth 401(k), I moved my new contributions into the Roth instead of the traditional.*  No, it does not make immediate financial sense, because we're in a pretty high tax bracket now.  But I like the future flexibility it provides.

(Presuming future administrations don't fuck with Roth taxability, of course!  But you can plan for only so much). 


*The 401(k) was basically the only way I could really access the Roth accounts -- sure, I had some tIRA money from before I had access to a 401(k), but the contribution limits at the time were around $2K/yr, so even though I did the Roth conversion, it wasn't much.  And we've always been above the limit for independent IRA contributions (either Roth or traditional), so the 401(k) was the only way to get anything else into a Roth pre-retirement.

[reeshau]

For me, I consider the Roth as sort of a hedge against future tax changes.  I have a lot in a regular 401(k), and a lot in a standard brokerage account.  Withdrawing from both of those comes with tax consequences, so they have to be managed.  Having a Roth, OTOH, gives me another pot of money that I can withdraw from if needed in the future (e.g., to keep my taxable income below a given threshold).

I have a very similar viewpoint.  I FIRE'd in 2020 with 40% tIRA, 30% Roth, and 30% taxable.  A lot about that was circumstantial, squirreling away savings where I could.  But, in the spirit of a true hedge, I can adjust to a number of possibilities as tax policy changes over time.  I had thought, and adequately sized, my taxable account to run down until I could access the IRA's at traditional 59 1/2.  In the four years since, it has, instead, grown.  Yea, market!

I am doing Roth conversions to fill my low tax brackets, to tilt the balance away from tIRA as I consider RMD's getting closer--although, still 20 years away.

I also view our HSA in the same way.  Rather than spending it now, I view it as a medical-specific pool against large surprise costs.  (Really, could be any expense--we have past receipts!)