Mega Backdoor Roth IRA vs stocks

[FutureInternist]

If I have maximised my contributions on all the available options - 401k, Roth IRA, HSA, 529 - and now have the option to put some $ into mega backdoor Roth IRA, why does (doesn’t) it make sense to do that vs just take that $ and buy mutual funds outside of any retirement plan?

What advantage is there to do the mega back door vs just buying stocks?

Thanks.

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[TMP-SMX]

First of all well done you are doing great. Make sure you are managing debt, have plenty of emergency fund, and proper insurance in place just in case. The main risk depends on the plan (available investment options if has to stay in Roth 401k or on rules to move over to Roth IRA) and risk of failing nondiscrimination testing. Saving too much could lead to having to have that money returned or limited at some point in the year. My employer started it in the Fall and I did make a contribution and in service distribution in January. However, I decided against continuing it since I think they are at high risk of failing testing. With the pandemic I think that's a very high probability.

There's nothing wrong with a brokerage account if you are well read enough. It allows you to tax loss harvest and is more liquid than the Roth IRA just in case. If you are well diversified enough for long term investing you'll make money. The problem is growth in dividends is taxable and when you sell you pay capital gains (hopefully long term). It's also not as protected from lawsuit/creditors as retirement accounts but IRA vs 401k protection will vary by state.

 

[FutureInternist]

Non discrimination testing?
Tax loss harvest?

Whoa.... maybe I should have added an “explain like I’m 5” addendum

I do have all the basics out of the way -emergency expenses, STD and LTD insurance, life insurance on myself and spouse.

I guess eventhough it has Roth in its name, I was under the impression that one would pay taxes on it upon selling, but if that is not the case, then mega back door seems like a much better option than just buying target date mutual funds.

Thanks for the reply.

 

[TMP-SMX]

Haha. With how well you were doing with saving I assumed you had the basics down. Read the White Coat Investor/bootcamp book and/or join the Facebook page/forums. There's lots of books out there for the basics. It will help with asset allocation (deciding what to invest in in each different account). Target date funds are quick but you can save a bit on expenses if you do it yourself and create the same type of fund with ETFs/mutual funds and rebalance every year.

With Roth accounts the benefit is you already paid tax on it when it is contributed (after tax). Growth and withdrawals in retirement are tax free.

Tax loss harvesting is only available for a taxable account. This is where you sell one ETF/mutual fund and buy one similar but not "substantially identical". You get a tax break on that loss even though you are not really selling it.

 

[ThoracicGuy]

If I have maximised my contributions on all the available options - 401k, Roth IRA, HSA, 529 - and now have the option to put some $ into mega backdoor Roth IRA, why does (doesn’t) it make sense to do that vs just take that $ and buy mutual funds outside of any retirement plan?

What advantage is there to do the mega back door vs just buying stocks?

Thanks.

If you can put that money into a Mega Backdoor Roth, that allows you to put much more money into tax-advantaged accounts. Compare that to buying mutual funds in a typical taxable account and you are paying on capital gains each year.

Not many people have a Mega Backdoor Roth account available. You have to be able to put post-tax money into the account AND make transfers out to a Roth IRA without separation of employment to have a true Mega Backdoor.