Redirecting Taxable investments to Roth 401k

Introduction

This applies to those in the USA who

• have access to an After-tax 401k contribution with instantaneous in-plan conversion to Roth 401k, aka, Mega Back Door Roth (MBDR)
• already contribute up to the IRS maximum to the pre-tax/Roth 401k sources 
• have a taxable brokerage account with sufficient assets that can be leveraged to facilitate the MBDR.

Usually most people set their retirement contributions such that their net pay covers living expenses with possibly some left over for savings / emergency fund. Assuming one is already maxing out contributions to tax-advantaged retirement accounts (to the extent allowed by the tax code) and has accumulated a non-trivial amount of investments in a taxable brokerage, the question naturally arises:

Does it make financial sense to take advantage of the MBDR even if it means that one has to draw down on the taxable brokerage to fund expenses?

The comparison is between these two scenarios:

1. Net pay (post tax) is used to fund living expenses with neither contributions to Roth via MBDR nor withdrawals from taxable brokerage account
2. Cash equivalent to net pay is withdrawn from taxable brokerage to fund living expenses while the remainder of net pay, after paying Long Term Capital Gains (LTCG),  is used to contribute to the  Roth via MBDR

The scenarios are defined to keep the cash available for spending the same between the two. In both scenarios the money is invested in identical instruments over the same investing period so that we may do an apples-to-apples comparison. Tax rules used are circa 2026.

Definitions

Term	Description
$P_i$	Net pay (post tax) that would nominally be used for living expenses
$B$	Basis in taxable brokerage for $P_i$ that would be withdrawn in scenario $2$
$G$	Investment growth (total return) multiplier over the investing time-period $(0 \le G \le +\infty)$
$D$	Tax drag multiplier in  taxable brokerage over the investing time-period prior to any withdrawals $(0 < D \le 1)$. $D$ represents the cumulative reduction in terminal wealth caused by annual taxation; usually $D \approx 1$.
$T$	Effective tax rate on LTCG $(0 < T \le 1)$; usually $15\%$ in the USA

Scenario $1$

"Net pay (post tax) is used to fund living expenses with neither contributions to Roth via MBDR nor withdrawals from taxable brokerage account"

Since $P_i$ is not withdrawn from the taxable brokerage this amount stays in the account and grows by factor $G$. 

At the end of the time period, the final value is $P_f $ $=$ $P_i \cdot G \cdot D$.

If the final value is withdrawn at that point, taxes will be paid on the gains ($P_f - B$) to the tune of $(P_f - B) \cdot T$. Note that we assume the LTCG tax rate is the same at the point of withdrawal as it is at the start.

The remaining post tax value is $P_f - (P_f - B) \cdot T$ $=$ $P_f \cdot (1 - T) + B \cdot T$ $=$ $P_i \cdot G \cdot D \cdot (1 - T) + B \cdot T$.

Scenario $2$

"Cash equivalent to net pay is withdrawn from taxable brokerage to fund living expenses while the remainder of net pay, after paying Long Term Capital Gains (LTCG),  is used to contribute to the Roth via MBDR"

Since $P_i$ is withdrawn from the taxable brokerage, taxes due on it will be $(P_i - B) \cdot T$. 

The remaining cash value $P_i - (P_i - B) \cdot T$ $=$ $P_i \cdot (1-T) + B \cdot T$ is invested in the Roth.

At the end of the time period, given no tax drag in the Roth (i.e. $D = 1$), the final value is $[ P_i \cdot (1-T) + B \cdot T ] \cdot G$ $=$ $P_i \cdot G \cdot (1-T) + B \cdot G \cdot T $.

Since there is no taxation on the Roth, this is also the amount that's available post tax.

Summary

Scenario	Final value	Post tax value
$1$	$P_i \cdot G \cdot D$	$P_i \cdot G \cdot D \cdot (1 - T) + B \cdot T$
$2$	$P_i \cdot G \cdot (1-T) + B \cdot G \cdot T$	$P_i \cdot G \cdot (1-T) + B \cdot G \cdot T$

If we assume $D = 1$ (i.e., no tax drag on dividends which benefits scenario $1$), then the incremental advantage that scenario $2$ has over scenario $1$ on both final and post tax values is as below.

• Final value: $-(P_i - B) \cdot G \cdot T$
• Post tax value: $B \cdot T \cdot (G-1)$

Note that the difference in post tax value is completely independent of $P_i$ and depends primarily on $B$!

If $B \le P_i$ (which is a reasonable assumption for the nominal long term investor), the final value of the Roth account is lower and that reflects the opportunity cost of paying the LTCG taxes upfront. This benefits scenario $1$ if the entirety of the amount is inherited by descendants with a step-up in basis.

OTOH, the post tax value of the Roth account is higher if $G > 1$ (which is also a reasonable expectation for long term investing). This benefits scenario $2$ if the invested amount is expected to be used for retirement expenses. The scenario becomes more attractive as $B$ gets closer to $P_i$. OTOH, from a legacy standpoint, this is sub-optimal as the inherited (final) value is lower compared to scenario $1$.

Conclusion

Under the stated assumptions, redirecting taxable assets into Roth via the MBDR produces greater after-tax spendable wealth whenever the investments experience positive growth. The advantage increases with both investment horizon and cost basis.

Thus, if the goal is legacy, then its better to let the money stay in the taxable brokerage and use net pay to fund living expenses. Whereas, if the goal is to fund retirement expenses down the line, the contributions to Roth via MBDR is the way to go.