Preface
This article is for those in the USA who
- have access to after-tax 401(k) contributions with immediate in-plan conversion to Roth 401(k), aka, Mega Back Door Roth (MBDR), and
- have a taxable brokerage account with sufficient assets that can be leveraged to facilitate the MBDR.
Introduction
Usually, people focussed on saving and investing set their retirement contributions so that their net pay covers living expenses. Assuming one is already maxing out contributions to tax-advantaged retirement accounts and has accumulated a nontrivial 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 living expenses?
The comparison is between these two strategies:
- Default strategy: Net pay (after-tax) is used to fund living expenses
- No contributions to Roth via MBDR
- No withdrawals from taxable brokerage account
- Roth strategy: Cash equivalent to net pay is withdrawn from taxable brokerage to fund living expenses while the net pay - after setting aside some amount to pay capital gains tax - is used to contribute to the Roth via MBDR
The goal of this article is to determine the conditions under which the "Roth strategy" (in the precise manner defined above) yields better outcomes than the default strategy.
The strategies are defined to keep the cash available for living expenses the same. In both strategies, the money is assumed to be invested in identical instruments over the same investing period in order to make a fair comparison. Tax rules used are from $2026$.
An improved and more thorough analysis is now available at Redirecting Taxable investments to Roth 401(k) - An Improved Analysis. The rest of the text below this point should be considered as largely deprecated and likely of little use.
Glossary of terms
| Term | Description |
|---|---|
| $P$ | Net pay (after-tax) that would normally be used for living expenses ($P > 0$). $P$ is also the amount withdrawn from the taxable brokerage in the Roth strategy. |
| $B$ | Cost basis of the amount withdrawn from taxable brokerage in the Roth strategy ($B > 0$). Normally, $B \le P$, but the opposite can also be true under some circumstances (e.g., market going through a dip) |
| $G$ | Investment growth (total return) multiplier over the investing period $(G \ge 0)$. $G$ is a function of the expected total return and the duration of the investing period. The longer the investing period, the larger the expected value of $G$. |
| $D$ | Tax drag multiplier in taxable brokerage over the investing period prior to any withdrawals $(0 < D \le 1)$. $D$ represents the cumulative reduction caused by annual taxation on dividends and on capital gains realized during rebalancing. The longer the investing period, the smaller the $D$. |
| $T$ | Effective tax rate on capital gains $(0 < T \le 1)$. It is assumed that $T$ is the same at the point of withdrawal as it is at the start. The analysis below can be easily extended to use different tax rates at the start $(T_i)$ and end $(T_f)$ if one so desires. $T$ is usually $15\%$ for Long Term Capital Gains in the USA. |
The results that follow are best interpreted in terms of the normalized cost basis defined as: $$B_N = \frac{B}{P} $$
Sidebar
Of all parameters $D$ is the most elusive. It depends on overall dividend yield of the portfolio and characteristics of rebalancing in the taxable account. Assuming (i) a portfolio composed of passive indexed ETFs like VT (or VTI $+$ VXUS) held long-term, and (ii) rebalancing done exclusively in tax-advantaged accounts, $D$ can be estimated to first-order.
As of Jun-$2026$, the dividend yield for VT (Vanguard Total World Stock ETF) is approximately $1.6\%$. If all dividends are treated as Qualified (a reasonable assumption), the tax rate on them will be same as $T$. For a nominal $T = 15\%$ tax rate, the dividend tax factor is $1.6\% \times 15\%$ $=$ $0.0024$, which makes $D$ $=$ $1 - 0.0024$ $=$ $0.9976$ $\approx$ $1$. This justifies the use of $D = 1$ to simplify expressions below, but it does weaken the robustness of conclusions reached.
As a reference, assuming $B_N = 0.7$, yearly return $7.177\%$, dividend yield $1.6\%$, and both dividend tax rate and capital gains tax rate as $15\%$, it takes over $20$ years for the dividend tax drag in the taxable account to overtake the costs incurred from paying capital gains tax at the start in the Roth strategy. So, under these parameters, if the planning horizon is well under two decades, it's likely acceptable to set $D = 1$. Not otherwise.
Default strategy
"Net pay (after-tax) is used to fund living expenses"
Since $P$ is not withdrawn from the taxable brokerage, this amount stays in the account and grows by factor $G$.
At the end of the investing period, the final balance is $P_f $ $=$ $P \cdot G \cdot D$.
If the balance is withdrawn at that point, taxes will be paid on the gains $(P_f - B)$ to the tune of $(P_f - B) \cdot T$. (The basis introduced by reinvested dividends is conveniently ignored here; in reality, the basis will be higher by a factor that's proportional to the effective dividend yield.)
The after-tax amount is then $P_f - (P_f - B) \cdot T$ $=$ $P_f \cdot (1 - T) + B \cdot T$ $=$ $P \cdot G \cdot D \cdot (1 - T) + B \cdot T$.
Roth strategy
"Cash equivalent to net pay is withdrawn from taxable brokerage to fund living expenses while the net pay - after setting aside some amount to pay capital gains tax - is used to contribute to the Roth via MBDR"
Since $P$ is withdrawn from the taxable brokerage, taxes due on it will be $(P - B) \cdot T$. This amount will be set aside from net pay.
The remainder of net pay $P - (P - B) \cdot T$ $=$ $P \cdot (1-T) + B \cdot T$ is invested in the Roth.
At the end of the investing period, since there is no tax drag in the Roth, the final balance is $[ P \cdot (1-T) + B \cdot T ] \cdot G$ $=$ $P \cdot G \cdot (1-T) + B \cdot G \cdot T $.
As there is no taxation on Roth withdrawals, this is also the after-tax amount.
Analysis
| Strategy | Final balance | After-tax amount |
|---|---|---|
| Default | $P \cdot G \cdot D$ | $P \cdot G \cdot D \cdot (1 - T) + B \cdot T$ |
| Roth | $P \cdot G \cdot (1-T) + B \cdot G \cdot T$ | $P \cdot G \cdot (1-T) + B \cdot G \cdot T$ |
The incremental advantage, normalized to $P$, that the Roth strategy has over the default strategy on both final balance and after-tax amount is:
$$\Delta_{\text{balance}} = (1 - D) \cdot G - (1 - B_N) \cdot G \cdot T$$
$$\Delta_{\text{after-tax}} = (1 - T) \cdot (1-D) \cdot G + B_N \cdot T \cdot (G-1)$$
Note that $\Delta_{\text{balance}} > 0$ only if$$B_N > 1 - \frac{1-D}{T}$$which is independent of $G$. If the starting $B_N$ is too small, the investing period must be longer for $D$ to become small enough to satisfy the above inequality.
If $G > 1$ (a reasonable assumption for long-term buy-and-hold investing), then $\Delta_{\text{after-tax}} > 0$. The Roth strategy almost always wins as far as after-tax (spendable) amount is concerned.
$$\Delta_{\text{balance}} \approx -(1 - B_N) \cdot G \cdot T$$
$$\Delta_{\text{after-tax}}\approx B_N \cdot T \cdot (G-1)$$
In what follows, the approximate expressions above are used to arrive at rules of thumb.
If $B_N < 1$ (a reasonable assumption for long-term buy-and-hold investing), then $\Delta_{\text{balance}} < 0$. This reflects the opportunity cost of paying the capital gains taxes upfront in the Roth strategy. The closer $B_N$ is to $1$ the lower the opportunity cost in the Roth strategy.
Note that $\Delta_{\text{after-tax}}$ depends on $B_N$ and does not depend on $P$ directly. This is a key, and possibly surprising, takeaway. The Roth strategy yields a larger $\Delta_{\text{after-tax}}$ under the following conditions:
- Larger (normalized) cost basis
- Larger capital gains tax rate
- Longer investing period (i.e., larger $G$)
- Higher tax drag (i.e., smaller $D$) in the taxable account
If $B_N > 1$ (i.e., the investments were under-water at the beginning), then $\Delta_{\text{balance}} > 0$ as well, making the Roth strategy attractive on both $\Delta_{\text{balance}}$ and $\Delta_{\text{after-tax}}$ fronts. Whlie this is a simplistic view of the tax treatment for capital losses, the general point nevertheless holds.
Retirement Spending
If $G > 1$ (a reasonable expectation for long-term buy-and-hold investing), then $\Delta_{\text{after-tax}} > 0$. This means that the Roth strategy is the better choice for a retirement spending goal. It becomes more attractive as the basis gets larger ($B_N$ gets closer to, or exceeds, $1$).
Legacy / Inheritance
There is a window of time during which $\Delta_{\text{balance}} < 0$. If the inheritance happens in this window, and if the heirs liquidate immediately upon inheritance, then the default strategy is objectively better as the heirs receive a step-up in basis in the taxable brokerage with no taxes due on the liquidation. This would require tremendous foresight by the account owners and there may be unfortunate outlier cases (e.g. terminal illness with a known life horizon) where this could be planned.
In the general case though, it is not immediately clear which strategy is always better for a legacy goal. IRS rules require heirs to liquidate the Roth at the end of $10$ years anyway. So, a fair comparison is between the effective after-tax (spendable) balance of the taxable account with the corresponding balance in the Roth at, or before, the end of $10$ years.
Legacy Taxable
If the heirs continue to let the account grow with growth multiplier $G_h$ $(G_h \ge 0)$, effective capital gains tax rate $T_h$ $(0 < T_h \le 1)$, tax drag multiplier $D_h$, then
- Inherited basis $B_h$ $=$ $P \cdot G \cdot D$
- Post-growth balance $=$ $B_h \cdot G_h \cdot D_h$
- Capital gains $=$ $B_h \cdot G_h \cdot D_h$ $-$ $B_h$ $=$ $B_h \cdot (G_h \cdot D_h - 1)$
- Taxes due $=$ $B_h \cdot (G_h \cdot D_h - 1) \cdot T_h$
- After-tax balance $=$ $B_h \cdot G_h \cdot D_h$ $-$ $B_h \cdot (G_h \cdot D_h - 1) \cdot T_h$ $=$ $B_h \cdot G_h \cdot D_h \cdot (1- T_h) + B_h \cdot T_h $ $=$ $P \cdot G \cdot G_h \cdot D \cdot D_h \cdot (1- T_h)$ $+$ $P \cdot G \cdot D \cdot T_h$
Legacy Roth
Under the same conditions as above
- Inherited balance $B_h$ $=$ $P \cdot G \cdot (1-T) + B \cdot G \cdot T$
- Post-growth balance $=$ $B_h \cdot G_h$ (as $D_h = 1$ for the Roth)
- Capital gains or taxes due $=$ $0$
- After-tax balance $=$ $B_h \cdot G_h$ $=$ $P \cdot G \cdot G_h \cdot (1-T) + B \cdot G \cdot G_h \cdot T$
Legacy Analysis
With some algebra, the incremental advantage, normalized to $P$, in the after-tax balance that the legacy Roth has over the legacy taxable is:
$$
\begin{aligned}
\Delta_{\text{legacy-after-tax}} &= (1 - D \cdot D_h) \cdot G \cdot G_h - (1 - B_N) \cdot G \cdot G_h \cdot T \\
&+ (G_h \cdot D_h - 1) \cdot G \cdot D \cdot T_h \end{aligned}
$$
If both $D$, $D_h \rightarrow 1$, then $$\Delta_{\text{legacy-after-tax}} \approx -(1 - B_N)\cdot G \cdot G_h \cdot T + (G_h - 1) \cdot G \cdot T_h$$
In the additional special circumstance $T_h = T$, $$\Delta_{\text{legacy-after-tax}} \approx (B_N \cdot G_h - 1) \cdot G \cdot T$$
The legacy Roth yields a better outcome than the legacy taxable when $B_N \cdot G_h > 1$ or, equivalently, when $G_h$ exceeds $1 / B_N$. So, if the heirs hold the account long enough for $G_h$ to attain the necessary value, then the Roth strategy is better for a legacy goal.
Per IRS rules in $2026$, the longest holding period for an inherited Roth account is $10$ years. Over this time, the nominal expected $G_h$ is approximately $2$ ($7.177\%/\text{yr}$ compounded over $10$ years). Thus, if $B_N > 0.5$, then the legacy Roth wins. Once again, a larger basis benefits the Roth strategy.
All said, whether the Roth strategy is the better one for the legacy goal depends on too many factors to extract simple rules of thumb. Having a larger basis and a longer holding period makes it more likely that the Roth strategy wins in the end.
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.
For a legacy goal, however, the outcome is not so certain.
Epilogue
Below are the results of a simple calculation for the final balance and after-tax (spendable) amount for both strategies given the following inputs:
- $P = 100,000$
- $B = 70,000$ ($\implies B_N = 0.7$)
- Investing period $= 15$ years
- Capital return $= 7.177\%/\text{year}$ # Does not include dividend returns
- Dividend return $ = 2.75\%/\text{year}$
- Initial capital gains tax rate $ = 15\%$ # used for Roth strategy (withdrawal at beginning)
- Final capital gains tax rate $= 15\%$ # used for default strategy (withdrawal at end of investing period)
- Dividend tax rate $= 19\%$ # Assuming a mix of ordinary and qualified dividends
The "Total Tax" column below reflects the cumulative tax that has been paid within the account until the end of year that corresponds to each row.
It takes $10$ years for the Roth balance to overtake the balance in the taxable account. So, in this scenario, the investing period needs to be at least $10$ years in order for the Roth strategy to be the better choice for a legacy goal.
Meanwhile, for a retirement spending goal, the Roth is the better choice from the get-go.
Default Strategy
Year | Balance | Total Tax | Tax Drag
1 | 109404.50 | 522.50 | 0.48%
2 | 119693.45 | 1094.14 | 0.91%
3 | 130950.02 | 1719.54 | 1.31%
4 | 143265.21 | 2403.75 | 1.68%
5 | 156738.59 | 3152.31 | 2.01%
6 | 171479.07 | 3971.27 | 2.32%
7 | 187605.82 | 4867.25 | 2.59%
8 | 205249.21 | 5847.49 | 2.85%
9 | 224551.87 | 6919.92 | 3.08%
10 | 245669.85 | 8093.20 | 3.29%
11 | 268773.87 | 9376.82 | 3.49%
12 | 294050.71 | 10781.17 | 3.67%
13 | 321704.71 | 12317.58 | 3.83%
14 | 351959.42 | 13998.49 | 3.98%
15 | 385059.45 | 15837.48 | 4.11%
Pre-Tax Summary:
Balance: 385059.45
Capital Gains Tax: 0.00
Total tax: 15837.48
Tax Drag: 4.11%
After-Tax Summary:
Balance: 342300.53
Capital Gains Tax: 42758.92
Total tax: 58596.40
Tax Drag: 15.22%
Roth Strategy
Capital gains tax of $4,500.00$ is paid at the beginning when $100,000.00$ is withdrawn from the taxable account. The initial principal redirected to Roth is $95,500.00$.
Year | Balance | Total Tax | Tax Drag1 | 104980.29 | 0.00 | 0.00% 2 | 115401.68 | 0.00 | 0.00% 3 | 126857.60 | 0.00 | 0.00% 4 | 139450.76 | 0.00 | 0.00% 5 | 153294.03 | 0.00 | 0.00% 6 | 168511.53 | 0.00 | 0.00% 7 | 185239.67 | 0.00 | 0.00% 8 | 203628.41 | 0.00 | 0.00% 9 | 223842.61 | 0.00 | 0.00% 10 | 246063.46 | 0.00 | 0.00% 11 | 270490.18 | 0.00 | 0.00% 12 | 297341.74 | 0.00 | 0.00% 13 | 326858.86 | 0.00 | 0.00% 14 | 359306.14 | 0.00 | 0.00% 15 | 394974.46 | 0.00 | 0.00% After-Tax Summary: Balance: 394974.46 Capital Gains Tax: 4500.00 Total tax: 4500.00 Tax Drag: 1.14%
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