Mega backdoor Roth vs taxable

[Matthew Harrigan]

I am a retirement account maximalist. I want to make sure I'm not missing something.

I can withdraw penalty free from prior Roth contributions and 5+ year old conversions, an inherited tradtional IRA, an HSA with prior medical receipts, among several other options. I have almost zero in taxable accounts outside a savings account. I can contribute to 23500 to traditional 401k, 8550 to HSA, and 7000 to Roth IRA. The question is whether to contribute up to another ~30k via mega backdoor (MBD) or to a taxable account. MBD meaning after tax 401k contributions rolled over into a Roth IRA.

I struggle to foresee a scenario where taxable beats MBD. I can withdraw quite a bit from retirement accounts without penalty. I can contribute 30k this year to my Roth IRA via MBD and withdraw it next year for instance. I probably won't withdraw it, so the long-term tax savings and asset protections are appealing.

Anything I am misunderstanding or not considering?

Thank you

[Max Gallagher]

Maybe a few days late to this post but thought I could provide some clarity as a Certified Financial Planner. I'm a big fan of Mega Backdoor Roths if your plan allows for it (ie. automatic in-plan Roth conversions). 

In a head to head comparison of pure after-tax growth, MBDR wins as all of the earnings on contributions are tax free whereas earnings in a taxable account are subject to capital gains upon sale. For example, say you contribute $30k via MBDR to your Roth 401(k) this year and over the next 15 years it grows by 8% annually to ~$100k. If this $30k was invested in the Roth 401(k) you could withdrawal $100k with no tax consequences. If this $30k was instead invested in a taxable brokerage account, you'd pay capital gains taxes on the $70k of growth and be left with a tax bill as high as $14k. That's a sizeable tax bill that can be avoided just by investing in a different type of account. 

Now we know there are no free lunches, so it's important to understand the tradeoffs. Withdrawing from retirement accounts in your 40's is not as easy as made out in your post and pointed out in some replies.. there likely would be a 10% penalty associated with withdrawals even if its contributions. While you might have more flexibility in avoiding the penalty if structured as a 401(k) loan or a hardship withdrawal, I would only recommend contributing to a Roth if you have confidence that you won't need to touch it until 59.5. 

Seeing as you mentioned you have very little liquidity in after-tax and savings accounts, I'd likely recommend focusing on building up a buffer of accessible and liquid dollars in an after-tax brokerage account prior to maxing out a Mega Backdoor Roth. It also doesn't need to be all or nothing.. if you have the ability to save an extra $30k per year, you can save half of that into a brokerage account and the other defer into a Roth 401(k) via MBDR. My main priority (knowing very little outside of what you shared) is to make sure you have funds liquid and available so that you may weather a potential emergency.