How to do the Mega Backdoor Roth IRA

Ironically, the “Mega Backdoor Roth IRA” is not a Roth IRA at all: It’s technically an “after-tax” contribution to your employer-sponsored 401(k) or 403(b) plan, not to be confused with a Roth contribution, which is much more boring and akin to going through the “front door.” 

Unfortunately, not all 401(k) plans allow for after-tax contributions beyond the standard, employee elective deferral of the $23,500 contribution limit (of the four companies I’ve worked for, only two have allowed it). 

But in 2025, this strategy allows you to get another $46,500 of Roth dollars in the bank on top of your regular $23,500 contribution to a 401(k) or 403(b).

Bonus, albeit a potentially confusing one: You’re still in the clear to contribute $7,000 per year to a Roth IRA or Backdoor Roth IRA if you want to, as well. Your IRA activity is wholly separate from today’s discussion of juicing your employer plan for all it’s worth.

Why? Because the actual contribution limit for 401(k)s in 2025 is a whopping $70,000. 

Here’s how it works:

1. In your company’s retirement portal, you elect to contribute after-tax dollars above and beyond the $23,500 limit.

2. Your plan administrator then (a) converts them to Roth in-plan or (b) permits in-service distributions, allowing you to roll over the funds to a Roth IRA.

…and that’s about it. I pulled an old screenshot from a former employer’s contribution page so you can get a sense for what this might look like on the back end:

Since my base pay at the time was $128,000 and I wanted to contribute a pre-tax $22,500 as well as an after-tax $6,500 (I basically wanted to mirror a regular Roth IRA limit in 2023), my “percentages” were 17% and 5%, respectively. You’ll probably see some language around a “Roth In-Plan Conversion” that’ll ask if you want to “convert after-tax contributions” to Roth, and your answer is a resounding yes. 

Candidly, it might be more trouble than it’s worth if you have to manually roll over and convert the after-tax contributions every month, but if your plan converts them to Roth in-plan for you and you can afford it, it’s probably a no-brainer to get a few more tax-advantaged dollars working in your favor.

If you are faced with the manual-only option, some people like to wait until the end of the year to roll over a full year’s worth of their after-tax dollars to their Roth IRAs—but it’s worth noting you’ll pay additional tax at that point on the growth of those after-tax dollars at the point of conversion (assuming they grew, of course).

It’s also worth noting that your employer match counts toward the overall $70,000 limit. If you contribute $23,500 and your employer contributes $10,000 (#goals), your 401(k) bucket technically has $36,500 of “room” left ($70,000 – $23,500 – $10,000 = $36,500).

Importantly, there’s no income limit for this (yet!), so people who earn too much to contribute directly to a Roth IRA (or don’t want to bother with a regular Backdoor Roth IRA) may find this a more seamless way to get both pre-tax and after-tax/Roth exposure in one fell swoop. Now, to find a job with a tech company that offers this Mack Daddy benefit…

2024 Roth IRA income limits

Someone making six figures who also reads this blog is likely contributing the maximum to their Traditional 401(k), which means they’re probably claiming a deduction of $23,500 in 2025—which means they’d probably need to make closer to $188,500 single and $293,000 married in order to be totally phased out (because $293,000 married minus a $23,500 contribution for each partner is that upper $246,000 limit).

Why a Roth IRA is worth your time

Besides tax-free growth and withdrawals, the Roth IRA allows you to access the principal at any time before age 59.5 with no penalties (the growth on that principal is treated differently, though). 

Because of this easy-access feature, Roth IRAs are a super flexible investment vehicle for retirement (and even more flexible if you’re planning to be an early retiree, thanks to the whole “no penalties on your own contributions before you’re gray” thing). 

But what should you do if you’re unable to contribute to a Roth IRA because you make too much money? The Backdoor Roth IRA.

You should be able to pull this off without any tax penalties, but there’s one scenario to be aware of that might trigger a tax bill that I note at the end of the steps below. Make sure to read through to the end, because it will likely determine whether or not you choose to attempt this.

(You might also wonder if a taxable brokerage account is a better fit—and it might be, but think about the main similarity between a Roth IRA and a regular ol’ taxable investing account: You’re already using post-tax dollars. Where you may otherwise jump straight to taxable investing after your 401(k), this is a way to sock away $7,000 post-tax dollars in an account that’ll grow and be accessible tax-free forever.)

“Backdoor Roth IRA”: the TL;DR

In a Backdoor Roth IRA (the potential for sexual innuendos abound!), you create a Traditional IRA and make a non-deductible contribution (in other words, you’re using money you’ve already paid taxes on, which likely means it’s just the money sitting in your checking or savings account).

You’re probably like, “What’s the point of a Traditional IRA if the main benefit of the account doesn’t work for me?” But the ability to convert IRAs from Traditional to Roth is your bread and butter here. 

Here’s how it works:

1. Open a Traditional IRA account with your brokerage firm of choice. Open a Roth IRA with the same firm, if you don’t have one with them yet.

2. Fund the Traditional IRA to the 2024 IRA contribution limit (assuming that’s your plan for the year): $7,000. Leave the funds in the money market/cash balance; don’t invest it yet!

3. Wait a few days for the funds to settle.

4. Convert the cash to Roth (big brokerage firms know how to do this; if you need help, you can ask! There should literally be a button that says “Convert to Roth”). Because the funds aren’t invested yet, there will be no gains to pay taxes on. You already have a Roth IRA ready and waiting from Step #1.

5. Invest in the index funds of your choice within the Roth IRA with the funds you converted.

And…that’s it.

There’s just one small snafu to note, per my earlier comments about being able to access contributions at any time: When you convert funds to Roth in the Backdoor Roth IRA process, you now have to wait five years before you can access the principal (hopefully this is no showstopper for someone with their other financial ducks in a row).

When does this make sense?

If you meet the qualifications above and you’re feeling comfortable so far, I’d consult an accountant for one last gut-check, then give it a go. However, one thing to note from a tax optimization standpoint is that this process should probably come after you’re able to contribute the maximum to your 401(k) for the year. 

You can do them simultaneously, of course, but if you’re not getting the most tax-deferred bang for your buck at your income level, the Backdoor Roth IRA probably shouldn’t be priority #1, in my opinion.

When shouldn’t you do a Backdoor Roth IRA?

If you already have Traditional IRAs lying around like discarded Fiji water bottles (I assume you drink Fiji water because…well, you know), you’re going to be subject to this convoluted thing called the IRS pro rata rule, which will result in a tax bill. 

I spent about an hour reading IRS.gov articles about this rule, and now, all I’m (kind of) confident about is this: The breakdown between your existing pre- and post-tax dollars in your existing Traditional IRAs will determine the amount of your Roth conversion that’s taxable.

Yeah, I didn’t get that either. Let’s do an example.

If you already have $50,000 in a Traditional IRA that you created with deductible, pre-tax contributions (before you were a high roller) and you add another $7,000 post-tax with the intention of converting it to Roth, only about 11.5% of the total amount in your Traditional IRAs is post-tax ($6,555 of the $57,000).

As such, 11.5% of your Roth conversion will be tax-free—but you’ll be taxed on the other 88.5% of the conversion. If you’re in the 24% income bracket, you’d pay $1,570 in taxes on the conversion of post-tax dollars to Roth (the 88.5% of your conversion ($6,555) x 24%). 

TL;DR: Depending on how much money you’ve got in those other IRAs, your tax bracket, and how much you’re trying to roll over, this could create a hefty tax bill come April.

For that reason, I’d really only attempt this (on your own) if you do not have a big balance in a Traditional IRA already (including SEP IRAs, rollover IRAs, etc.—and to be super clear, your Traditional 401(k) doesn’t count!).

May 2021 was the, “Wait a second – I think I’m going to be too far over the income limit to deduct my way back down. Better stop adding fuel to this tax-free fire just in case,” moment.

That’s a good place to start. Figure out how much you’ve contributed in error. If you don’t have a Wealth Planner (shameless plug!), you can just look at the transaction history in your Roth IRA and filter by “deposits” or “contributions,” depending on your brokerage firm.

I added $2,500 to mine in 2021 and – in short – needed to remove those excess contributions.

Roth IRA contributions can be withdrawn at any time without penalty, but the earnings can’t be

Obviously, the entire point of funding a Roth IRA is to invest your money for tax-free growth. My $2,500 wasn’t sitting there uninvested with its thumb up its ass – it was earning.

So while I knew I could pull out my contributions without issue, I was confused about the earnings.

I submitted a Support ticket to M1 Finance and got this message back from a dude named Dexter. Let’s decode it below (my thoughts in italicized parentheticals):

Hi,

Thanks for reaching out to M1 Finance. (You’re welcome, Dexter.)

Unfortunately, it is past the deadline for our firm to change the contribution year for one of your deposits to a 2021 year instead of 2020. Only your excess contribution can be removed after this deadline.

(Shit. I was afraid of this. I had asked if we could potentially re-characterize my 2021 contributions that occurred before the filing deadline to 2020 contributions, when I wasn’t over the income limit, but no dice.)

To fix this, you can simply withdraw the over-contributed funds from your M1 account using the Transfers tab on the Web platform. Please select “Excess Contribution Removal, After Tax Deadline” as the reason. You will remove only the amount of the excess; no earnings or loss will be calculated.

(It took me a while to figure out how to do this, but basically, it was a designation during the withdrawal process where I had to select the bolded option. This part threw me for a loop, though, because I was withdrawing BEFORE the tax deadline – but I trusted Dexter without listening to my common sense.)

You will owe the IRS 6% excise tax for every year the excess remains in the IRA. Additionally, you may not deduct the excess amount when fling your taxes. The excess amount removed will not be taxable if your aggregate contributions for the year do not exceed the annual contribution limit.

(Pretty sure he included the language about not being able to deduct the excess amount to cover Traditional IRA scenarios, because Roth IRA contributions aren’t deductible.)

However, if your aggregate contribution limit for the year exceeded the annual amount, then the excess is taxable and would be subject to the IRS 10% additional tax if you are under age 59½. For example, you made a $6,000 Roth IRA contribution but only qualified to make a $5,000 contribution. The $1,000 excess would not be taxed and penalized because it wasn’t more than the annual contribution limit.

(All right, Dexter, you’re making my head hurt.)

Thanks,

Dexter

All right – got all that?

Didn’t think so.

I moseyed over to my Roth IRA in M1, found the Transfers tab, and withdrew $2,500 from my Roth IRA. I ain’t going to lie – it hurt me.

But I still wasn’t sure: What about the earnings? Wouldn’t the growth of that $2,500 get taxed or penalized in some way? Help me, Dexter.

I replied and asked what the deal is, and this is what I heard back:

Hi Katie,

Thanks for reaching out to us about your 2021 over contribution. Because the over contribution occurred in tax year 2021, we will need to re-code this withdrawal as a “before tax deadline” excess contribution removal. We will submit this change to our clearing firm to make the correction. As for gains, or Net Income Attributable (NIA) of the excess contribution, you’ll want to remove those funds by making an “excess contribution removal, before tax deadline” withdrawal as well, and indicate that the full amount withdrawn is the Net Income Attributable.

Please let us know if you have any questions, and we will provide an update once we have heard back from clearing firm.

Best,

Brokerage Operations
M1 Team

So what did we learn? Katie should always trust her gut, instead of Dexter (just kidding) – but it sounds like I was initially misdirected in choosing “After the Tax Deadline,” and I should’ve followed my gut there.

How to calculate (and withdraw) the earnings on your over-contribution

Regarding the gains in the account, they’re evidently called Net Income Attributable in the #biz, and while it’s good to know I have to withdraw those, too, I’m still left with questions:

1. How am I supposed to calculate the gains on my $2,500 contribution? I suppose I could go in and look at the growth this year, but that would show me overall growth of the entire account – not just this year’s contributions. I replied and asked if they could provide that number for me (and now I’m growing increasingly annoyed that this feels like a demented scavenger hunt).

2. Am I going to get taxed or penalized for the NIA withdrawal? I wish they had clarified what that MEANS!

Fortunately, they sent over a Support article that initially frustrated me but ended up being pretty helpful. And while it absolutely gave me PTSD to AP Physics WebAssign, I finally figured it out:

In order to calculate your NIA, you have to know:

1. Your excess contribution [how much you contributed that you shouldn’t have; in this case, it’s $2,500]

2. Your opening balance [what the account value was before you made the excess contributions; in this case, it’s $14,875.33, and I figured that out by looking at my 2020 end-of-year statement for the balance on Dec. 31, 2020, before I made any 2021 contributions]

3. Your closing balance [what the account value is now, after the contributions and their #gains have had a minute to marinate; in this case, it’s $20,007]

4. Your “adjusted” opening balance [which is just the opening balance plus the excess contribution; in this case, it’s $17,375]

Got all that? My Roth IRA was valued at $14,875 at the end of 2020, and throughout 2021 I made $2,500 of illicit contributions, which bumped it up to $17,375. Because of growth, it became worth $20,007.

Here’s the calculation to calculate excess growth

Take your old closing balance and subtract your adjusted opening balance: $20,007 – $17,375 = $2,632

Divide the answer, $2,632, by the adjusted opening balance: $2,632 / $17,375 = 0.15148

Multiply the answer, 0.15148, by your excess contribution, $2,500: $2,500 * 0.15148 = $378.70

This means my excess contributions of $2,500 were responsible for $378.70 of gains in 2021, so I need to remove them (and pay taxes on them).

How it’s coded matters

Remember how the Support peeps wanted to verify with me that the distribution was coded with their clearing house as an “excess contributions removal, before the tax deadline”? That’s because while I could’ve removed my initial $2,500 deposit without issue, ordinarily, I’d need to pay a penalty for withdrawing the earnings. The Roth IRA’s whole shtick is that it allows your contributions to grow tax-free, and we aren’t allowed to touch that sweet nectar until we’re 59.5 or older.

To round out this fiasco, I accidentally withdrew the $2,500 in one single transaction before I knew about NIA (because Dexter failed to mention it!), and when I went back into withdraw the NIA separately, it asked me for an NIA calculation. I input the same amount, but:

Argh. Blocked again.

What to do if you remove the excess Roth IRA contribution without removing the NIA, or earnings

I circled back to my Support pals and asked how to handle this, screenshot in hand. They instructed me to withdraw $1 as my “Excess Contribution Amount,” then plug in the $378.50 as my “Net Income Attributable.” I did it, and the money was removed. It sounds like this is a tenable way to backpedal in case you’ve already withdrawn the excess contribution but forgot to pull the earnings.

What happens next: The 1099-R form

To close out this fiasco, you’ll receive a 1099-R form: the form that gets generated anytime you make a distribution from a retirement account. You’ll want to double-check that the word “Corrected” or “Corrective” is on the form to validate to the IRS that you weren’t just retrieving retirement funds for Coachella wristbands. You want the IRS to know you were legitimating your contributions for the year like the good little Rich Girl you are, right?

Is legitimating a word? I don’t know, but in this context, I think it works.

There are so many diehard Roth fans out there that I feel like I have to duck and cover when I say this, but I’m going to say it:

After doing the research that led to today’s post, I have no idea why anyone would ever opt for a Roth 401(k). Today, I’ll show you why.

It’s worth making the immediate caveat here that your Roth IRA is still a tax-advantaged vehicle I’d recommend using, and maybe even in tandem with what I’ll show you today—but my intent is to show you why the tax deferral benefits of contributing the maximum amount ($20,500) to a Traditional 401(k) simply can’t be beat, even if effective tax rates in the future double.

It all comes down to one very simple, yet powerful tweak:

You have to invest the tax savings.

Let me repeat:

You have to invest the tax savings.

While I don’t want to spend too much time today on background basics, let’s get on the same page about the difference between Roth and Traditional:

When you contribute to a Traditional retirement account, you don’t pay taxes on the contribution in your current tax year. Since contributions would be taxed (if they were Roth) in your highest marginal tax bracket, the savings are usually at least a few thousand dollars.

The benefit of the Roth account is that—while you do pay taxes in your highest marginal tax bracket this year—you don’t have to pay taxes on the growth later.

That begs the question: What happens “later”? How is Traditional 401(k) money taxed in retirement?

Let’s talk really quickly about what happens “later”—when you withdraw your money from your Traditional 401(k), you have to pay taxes on it, right? That’s the deal you signed up for.

But you don’t pay the taxes in your highest marginal bracket.

The money that you convert from Traditional to Roth in retirement is treated like earned income, which means you’re taxed on it as if it’s income from a job.

That means you get a standard deduction. That also means you’re taxed “bottom-up” instead of “top-down.”

In other words, if you know anything about our progressive tax system, you know that income from your job is taxed from the lowest tax bracket up (the first $10,000 or so is taxed at 10%, the second chunk of about $30,000 is taxed at 12%, so on and so forth).

While I thought I made a pretty compelling argument for why Traditional made more intuitive sense (skip the top-down taxes now, and pay bottom-up taxes later), I got some pretty intense feedback from Roth lovers who said that the tax-free growth in a Roth account still made it the obvious better choice.

I wasn’t so sure, especially because the “tax-free growth” argument for Roth ignores a big present-day benefit of the Traditional—the tax savings that you can invest elsewhere.

Even though people always say that tax rates will go up, I knew we were still comparing today’s marginal rates to the future’s effective tax rates (since the Traditional 401(k) conversions are being taxed like ordinary income when you withdraw them).

I decided to do a little experiment.

Before we launch in, my standard disclaimer stands: Trying to project anything 50 years in the future is a fool’s errand, at the end of the day. We’re just using averages and the current tax code to try to make the best choices we can for the future based on what we know today, but I’m not wholly convinced I won’t be an immortal half-robot living on Mars in 50 years from now exchanging CatCoin for organic oil changes.

The methodology

There are a few things we have to get on the same page about upfront.

I’m using averages that I’d consider pretty conservative so nobody slides in my DMs with a pitchfork to let me know that I’m an optimistic dumb bitch with a public relations degree (though… guilty). The important thing is, these same averages apply across the scenarios, so if Traditional is helped or hurt by one of our assumptions, Roth would be, too.

Here are the parameters for my little mad scientist Saturday night:

• 25-year working timeline—doesn’t really matter when you start, but to make it feel more real, we’ll pretend we’re starting to invest at age 30 and retiring at age 55

• Then, we’ll flesh it out another 25 years (to age 80) to demonstrate how the trend continues, though you’ll be able to extrapolate for yourself indefinitely

• 3% avg. inflation (also applies to the contribution limits, which will go up by 3% per year, too)

• 7% avg. rate of return (that means the “real” rate of return in these scenarios is actually about 4%, because it’s a 7% return minus 3% inflation – that’s really, really low, and I chose to do it that way to show that the stock market doesn’t have to go on a wild bull run in order for this to be true)

• Analyzing three situations: Earners in today’s 12%, 24%, and 32% marginal tax brackets (remember, your marginal tax bracket might be lower than you think after your standard deduction, so be sure to subtract the standard deduction from your gross income before you assign yourself into one of these buckets)

For the purposes of today’s exercise, we aren’t going to worry about state taxes. That may feel like a sloppy oversight, but since some people reading this work in a state with 0% state income tax and others work in a state that has 12% state income tax, I’m not going to mess with adding in a tax that’s so wildly variable.

Plus, most people retire in a different state than they work in, which would impact how their withdrawals are taxed – including hypothetical state taxes would muddy the waters for our “earning” taxes vs. “withdrawal” taxes because there are too many variables. That said, it’s something you can plan for.

It’s also worth noting (if you’ve read any of my other 401(k) hacking mania before) there are creative ways to get your money out of a Traditional 401(k) tax-free, too. But let’s pretend you’re not being strategic or savvy by pulling strategic amounts from different accounts and optimizing your tax strategy—you’re just pulling the full amount you need from a 401(k) or other taxable accounts for the sake of this analysis. 

The key is this: All that really matters is the amount of money being put in the accounts, because we can equalize everything at retirement by assuming a 4% safe withdrawal drawdown of assets. 

After all, you can’t spend money that’s not there—if someone wanted to make sure they didn’t run out of money, they’d more or less have to follow the 4% rule in retirement (give or take a few basis points, of course), so we’ll be simplifying details by using the following parameters:

• Person who contributes the maximum, inflation-adjusted contribution to their 401(k) (or 401(k)-equivalent account) over 25 years of a working life (I’ll run it for 12%, 24%, and 32% marginal tax brackets to show the difference)

• Starts drawing down the inflation-adjusted 4% safe withdrawal rate amount in year 26, then increases that withdrawal rate by 3% per year for inflation

• To determine the tax rate they’d face based on today’s tax code, I extrapolated backward to figure out what their “year 26 4% drawdown amount” would be worth in today’s dollars, assuming the tax brackets will continue to shift up with inflation (in other words, if you’re withdrawing $44,000 today and have no other income, your effective tax rate as a married person is 4.3%—in 26 years, the inflation-adjusted amount is $92,000, but it’s theoretically taxed at the same effective tax rate since the brackets would go up with inflation, too)

• To calculate the effective tax rate on certain levels of income withdrawals, I used this SmartAsset calculator—if you use it to play around, remember to only look at the first line item (federal tax) and state/local tax, and eliminate the FICA tax line item since those don’t apply to your retirement withdrawals

This is where everyone hollers about tax rates going up, so to address that, the other round of projections we’ll dive into double the effective tax rate to reflect higher taxes in the future. 

The thesis is pretty straightforward: If you invest in a Traditional 401(k) and capture the tax savings (in your marginal tax bracket) by investing that amount of money saved somewhere else (whether a Roth IRA or brokerage account), you fare better than if you’d just contributed the amount to a Roth 401(k) and paid the taxes in your working years. 

My ultimate recommendation to totally bone the system and leave the IRS in the dust is to invest the tax savings in a Roth IRA (but you could also use a taxable brokerage account). Think about it: You’ll be investing your tax savings each year from your Traditional 401(k) contribution to a Roth IRA. You’ll never pay taxes on that Roth IRA ever again, thereby giving you both (a) tax diversity and (b) access to the entire amount you see in the tables below.

Remember, withdrawals in retirement are taxed like ordinary income, less your FICA payroll taxes. 

You end up with about $1.8mm in your 401(k), all pre-tax funds, and about $450,000 in your “other” account—that could be a Roth IRA or a taxable brokerage account. The Roth IRA is likely the more optimal choice, but you do you—they’re your tax savings.

The obvious caveat to note here is that—had you contributed to a Roth 401(k)—your $1.8mm balance would be able to be drawn down tax-free, but you wouldn’t have the other $450,000 that you generated in the Traditional 401(k) example by investing the extra take-home pay you had from your tax savings.

Now it’s time to start drawing down, right? You’ve retired, you’ve got your ~$2.3mm between your two accounts, and it’s time to fuck around and find out what your safe withdrawal rate is (4%): $92,802. 

Of course, we know that this has the purchasing power of around $44,000 in 2022 dollars. 

So you’ll withdraw your $92,000 ($44,000 in 2022 purchasing power) and pay your taxes on it. 

How much of that $92,000 can you use? Well, you’ve gotta set aside some of it to pay your taxes, right? So how much? 

If you’re single, you’ll set aside about $7,500 to pay the taxes (an 8.13% effective tax rate, based on today’s rates) and if you’re married, you’ll set aside about $4,000 to pay the taxes (a 4.3% tax rate, based on today’s rates). 

Here’s what that looks like fleshed out (remember, you don’t pay FICA taxes anymore, and your federal taxes are calculated “bottom-up,” so the effective tax rate in retirement is lower):

In year 1 of retirement, that leaves you with about $85,000 if you’re single and about $89,000 if you’re married after you pay your taxes. 

It’s obvious that your effective tax rate on your withdrawals is lower than your marginal tax rate would’ve been in your working years had you contributed to Roth (in other words, you’re paying 8 cents or 4 cents per dollar in taxes in retirement as opposed to 24 cents per dollar in taxes on your would-have-been Roth contributions). 

That’s kinda the rub, right? You end up with more money by contributing to the Traditional if you’re investing your tax savings, too; a Roth hypothetical would look like the below, with a person contributing post-tax dollars to their 401(k) and ending up with $1.8mm total, instead of the “Traditional + invest the tax savings” person who ended up with $2.3mm. 

That’s because you used the “tax savings” to pay the taxes. Now, you’ve got $1.8mm of Roth, tax-free money to withdraw. 

Again, let’s assume you’re withdrawing 4% in line with the safe withdrawal rate:

There you have it: You can still withdraw 4% of your total balance, and you don’t have to pay any taxes on it, but you end up with a tax-free withdrawal of $75,000, as opposed to your taxable (or partially taxable) withdrawal in the previous example of $92,000, or a net $85,000/$89,000 after tax. 

That’s the simplest way to flesh out these two scenarios to show how the invested tax savings is a superior strategy. 

The 12% and 32% bracket examples are in the document, linked here and available for you to copy and play with. 

Spoiler: The 12% bracket example nets a Traditional + tax savings outcome of $2.1mm and a net drawdown ability (4% less effective tax rate) of $77,000 for singles and $80,600 for married, as opposed to a Roth outcome of a tax-free $1.8mm and $75,000 annual drawdown. The 32% bracket example is (unsurprisingly) most extreme; with a difference in net income for married filing jointly of $20,000 per year less for those who chose Roth instead of Traditional + invest the tax savings.

So the obvious next question is… what happens to our Traditional + tax savings if tax rates go up? 

The short answer is that the whole “effective tax rate + no FICA taxes” thing tends to do quite a bit of heavy lifting for lessening our tax burden in retirement. 

Besides that, you’re likely noticing that “the inflation-adjusted amount of $44,000 per year to live on” is not a whole lot—the reality is that, unless you’re saving and investing a ton of money (which is usually only made possible by MAKING a ton of money and being in a high tax bracket already), you can end up with $2mm and still not have THAT much to withdraw safely without depleting your principal balance. 

All that aside, let’s say they do go up. Let’s say your effective tax rate doesn’t just go up, but it doubles.

Then what happens? 

In our 24% example, that means our single Rich Girl’s tax rate jumps from an effective rate of 8% to 16%. She ends up paying about $15,000 in taxes and nets about $78,000. Woof. The married couple fares a little better; their effective tax rate doubles from today’s rate of 4% to a hypothetical 8% and they end up paying $7,400 in taxes and netting $85,000. 

Still, both fare better than the completely tax-free Roth withdrawal of about $75,000, rounding up. 

Again, that’s if effective tax rates double in the future—the Traditional + invest the tax savings still comes out on top. 

Conclusions

As stated before, I’m a public relations major with access to Excel and the tax code. I’m not an economist or financier, so it’s possible there are holes in this reasoning. 

And of course, we’re projecting 50 years into the future and doing so in a vacuum. There are other factors at play in people’s lives that don’t allow things to play out this neatly in real life.

That said…

Damn, I’m pretty confident in the fact that it proves the Traditional 401(k) is almost always going to be the preferable choice—as long as you invest your tax savings.

If you don’t invest your tax savings, well… yeah. You probably should’ve picked Roth.

But across the 12%, 24%, and 32% tax brackets, based on the way the progressive tax system works today, Traditional is your best option if you invest the tax savings each year. That doesn’t necessarily mean rates can’t go up—as you saw, the effective tax rates doubled and you still ended up ahead in the 24% bracket with Traditional + investing the tax savings.

And while it’s possible in your earning years you’ll fluctuate wildly between marginal tax brackets (I’ve been in three so far), the fact that the outcome was the same for all three (Traditional being preferable) should assure you that it probably doesn’t matter.

It all comes down to (a) effective tax rates and (b) investing your tax savings with the Traditional. Because your contributions are taxed top-down and your withdrawals are taxed bottom-up, your withdrawals will always be taxed more favorably than your contributions (assuming, of course, the progressive tax system doesn’t totally disappear).

Like I said—if you really want to screw the tax man, invest your Traditional 401(k) tax savings each year in a Roth IRA. That way, you can have your tax-free growth cake and eat it, too.

If you can’t beat ‘em, evade taxes like ‘em.

Just kidding – there will be no tax evasion here (you hear that, little FBI man that resides in my MacBook Air? No need to call Jim at the IRS, because everything in this post has its origins in tax code loopholes, laws, and cultural differences between the wealthy and the middle class).

I think it’s very much worth calling out: I am middle class. I was raised middle class, I make a middle class income, and I don’t consider myself “wealthy” in the sense that I’m talking about “the rich” here. However: I’d rather model my financial behavior after people with two commas in their net worths instead of one.

Isn’t avoiding taxes illegal?

Good question! Here’s the thing to understand right off the bat about taxes:

Your earned income and your property are the two things that are taxed the most aggressively.

Read that again.

Your earned income and your property are the two things that are taxed the most aggressively.

What do middle class people have in common?

Well, usually, they have good, middle class jobs (that pay earned income) and a primary residence (that faces unforgiving property taxes every year).

(Property taxes are the thing that everyone likes to ignore when making the argument that home ownership is an unquestionably good idea. At a national average of 1% of the value of your property every single year, your $350,000 home has an additional (average) $3,500 expense tacked on to its mortgage, interest, and insurance annually that goes toward nothing but Uncle Sam. Puke! The more expensive your home, the more you owe to the government. It’s one of the most effective ways to actually tax the wealthy, because you can’t move your home to an offshore bank account.)

Now, there’s nothing wrong with owning a home (see the “Cars & homes” category on this site for more articles about the math of home ownership), but the hard thing about the middle class is that 80% of middle class Americans have the majority of their net worth (60%) tied up in their home, which means most of their net worth is taxed over and over and over again on an ongoing, never-ending basis.

Conversely, the upper-middle class and “wealthy” in America (the demographic we’re attempting to model our financial habits after) own homes that account for only between 10 and 30% of their total net worth.

So what’s taxed un-aggressively?

Is un-aggressively a word? It keeps generating that ugly red line underneath it, but I’m plowing forward for the sake of the narrative.

You know what’s taxed at an almost laughably low rate?

Your long-term capital gains and your dividends – that is to say, any money that your money makes for you (in an investment account) is taxed so little it’s almost a joke. Let’s dive deeper.

Why the wealthy hide most of their net worth in investments

Historically, the middle class in America has put most of their net worth into their homes. And you know what? It’s not their fault: We’ve all been sold a lie that home ownership is the way you get rich (it’s not). To understand why, check out this post about when the math actually supports buying instead of renting.

But what happens if my entire net worth (or close to it) is “invested” in my primary residence?

Let’s say my primary residence is worth $500,000 and I have about $25,000 in cash. My total net worth is $525,000, assuming I own the home outright and no longer owe any payments on it.

Let’s also pretend that my income is $125,000 per year. Because I like nice things, I don’t really invest any of the money – I just take it all as cold, hard cash, spend most of it, and shuffle whatever’s left over into that $25,000 cash sitting in my savings account on the side.

If you’re looking at this scenario thinking, “Hey, that’s not so bad! Half-a-million-dollar home, $25,000 in cash, and a six-figure salary? I’d take it.”

My friends, this person is a tax NIGHTMARE!

Let’s explore why:

• Assuming they pay the national average in taxes on their $500,000 home, they’re looking at a $5,000 property tax bill annually.

• Their earned income, $125,000, is their only source of income – in other words, they’re only living on earned income – no capital gains or dividends to speak of. This person would be taxed on the full $125,000, paying $29,101 in federal income taxes and FICA (want to calculate your own? I’m using this calculator).

Our hypothetical middle classer is paying nearly $29,000 in taxes this year – more than the amount they’ve got in their savings account liquid. They’re technically “worth” over half a million dollars, but they can’t use their home to pay their income taxes.

How would investing have helped this individual?

Investing is beneficial for your tax liability (in other words, it can help shield you from taxes) in two ways:

• When you invest in a pre-tax account, you shield that money from Uncle Sam’s bill collectors because you’re “deferring” the taxes for a later date (but if you’re a loyal Money with Katie reader, you know you can also collect it later tax-free too if you perform the Roth IRA conversion ladder and keep your conversions under the standard deduction).

• When you get to the point where you can live off investment income (i.e., invest aggressively enough for long enough), you can “pay” yourself a ridiculously high amount before the money is actually taxed.

Let’s break this down.

First, it’s helpful to look at the tax brackets on earned income:

As we can see here, our friend is being taxed in the 24% tax bracket on the last $20,000 he or she makes. Of course, the standard deduction will eat up some of that – but the point stands that they aren’t doing much to help themselves lower their tax liability.

(The earned income tax brackets are progressive, which means your income is taxed at different rates. Your first $10,000ish is taxed at 10%, the next $35,000ish is taxed at 12%, etc. – which means the person’s entire income isn’t taxed at 24%, only the chunk from $103,350 to $125,000.)

Pretty gnarly, huh? But what if this person had been investing in the market for the last 15 years?

Better yet, what if this person had avoided the half-a-million-dollar McMansion and instead invested heavily in low-cost, diversified index funds that were now producing dividends and capital gains this person could live on? (In other words, what if they were nearing financial independence?)

Let’s look at how your investment income is taxed (assuming no other income; in other words, you’re living off your investments instead of a salary):

Yep, you read that right: A single person can withdraw up to $48,350 per year from their investment account for the low, low price of 0% in taxes paid, if it’s their only source of income.

$48,350!

And what if you want to withdraw, say, $300,000 per year? You’re living high on the hog! You’ve got six months to live! Time to finally pack your bags for Yacht Week and buy that Gucci tracksuit you’ve been eyeing.

No problem. You’ll only pay 15% in taxes on up to (I’m throwing up) $533,400.

You know what EARNED income bracket gets charged 15%? The one between $40,000 and $80,000.

The government is basically incentivizing you to invest like a crazy person to the point that you can live off your investment dividends instead of a traditional job.

When you look at it from a tax perspective, it makes almost no sense to have a real job. In fact, it makes ALL the sense in the tax world to try to invest as aggressively as possible with your earned income so you can get to the point where you can live off your capital gains, which are taxed at a much, much more forgiving rate.

And that’s why strategically wealthy people shovel all their money into investments that generate income that isn’t (or barely is) taxed.

So now you can see why it’s to your massive benefit to have enough in investments to not have to work (surprise!), but what about on the front-end? How could our friend have avoided such a high tax bill?

Pre-tax investment accounts. These are what we like to call tax shelters, because the federal government can’t touch it until you go to use it later, strategically at a time where you’re in a lower tax bracket. Checkmate.

What would’ve happened if our friend had maxed out their 401(k) instead of taking home all their income?

At an annual maximum contribution of $23,500, our friend could’ve lowered their taxable income like this:

Income: $125,000

2025 standard deduction for a single person: Subtract $15,000 for the standard deduction, which lowers taxable income to $110,000

401(K) maximum contribution: Subtract $23,500 for the 401(k) contribution, which would go into the 401(k) completely untaxed

New taxable income: $86,500

There are other tax-sheltered accounts this person could play with, like HSAs and IRAs, but for the sake of our example today, we’ll keep it simple.

• An HSA, or Health Savings Account, is an account that you’re eligible for if you have a high-deductible health insurance plan – the contribution limit for a single person in 2025 is $4,300. When I found out I owed $5,000 in taxes this year because I underpaid throughout the year, I put the maximum contribution into an HSA to defer that income from taxation and ended up lowering my tax bill to $4,000. One step at a time! The cool thing about the HSA is that you can actually invest the money in it once it crosses the $1,000 mark (typically).

• An IRA, or Individual Retirement Account, comes in two flavors – Traditional and Roth – and I’ve written about them extensively. A traditional IRA, which would’ve been a great tax deferral vehicle, wouldn’t work in this example because our friend with a six-figure income is over the income limit. #sad.

Now? Our friend owes ~$23,500 in federal taxes and FICA, roughly $6,000 less.

That’s an annual savings of $6,000 by doing nothing more than putting your earned income into a tax-sheltered account.

Theoretically, if you had no other earned income, you could “make” $96,700 as a married couple filing jointly in dividends and capital gains and live on it completely tax-free.

The trick? Invest aggressively enough, early enough to build up a massive portfolio that’s capable of throwing off $96,700 per year in capital gains. Easier said than done, but hopefully this serves as spite-motivation to stiff the Feds on the taxes you’d otherwise be paying them if that $96,700 were earned income.

When I first learned about early retirement, I was blown away—so much so that I didn’t really ask any questions about what happened AFTER you retired at 35 or 40 years old.

All I knew was I needed to save as aggressively as possible, as early as possible.

But then I started to envision the actual logistics of early retirement and withdrawing money from these accounts that are designed to be used after age 59.5, and I wasn’t sure what it would entail. I was confident the early retirement community had the answers, though, and I wasn’t too concerned given the fact that these questions were still about 15 years away from relevance for me personally.

I realize this is a long way away for most of us, but I think it’s good to start taking these logistics into consideration now so you have an idea of how you’re going to plan for early retirement. For some of us, it might be less than 20 years away—and planning your #ExitStrategy will help you confirm that you’re setting up your accounts correctly for later.

More importantly, it might encourage you to keep aggressively contributing to your Traditional 401(k), because you’ll see that you can use this money whenever thanks to this tax loophole! Might as well maximize your tax-advantaged account to avoid the annual taxes that eat into your returns in other taxable investing accounts, right? Right.

Roth IRA Conversion Ladder

Today I want to talk about something called a Roth IRA conversion ladder, because it’s the magic tax loophole that enables you to use your Traditional 401(k) before age 59.5 without the 10% penalty that normally applies.

Here’s what to do:

1. Roll over your entire Traditional 401(k) to a Traditional IRA. This is a standard financial move in retirement or whenever you leave a company. Your 401(k) provider can help if you’re confused (so can a company I like called Capitalize; I’ve used them thrice now).

2. Perform a Roth IRA conversion with a strategically pre-determined chunk of the Traditional IRA (more on this in a moment). This is also pretty common, but there are tax implications. That’s why you want to wait to do to his until you’re retired and your taxable income is low (or nothing), because the amount you convert from Traditional to Roth will be taxed in your income bracket.

3. Wait 5 years. On January 1 of Year 6, you can use that converted money (the money you converted from a Traditional IRA to a Roth IRA) without any 10% penalty! Seriously!

I have no idea why this bit of tax code exists or works, but as of this original writing (December 2022, updated for 2025), it does.

The reason it’s called a ladder is because you’ll do it every year, that way (after the first five years) you’ll have a chunk converted and ready to go every single year.

How to pay no taxes on your Roth IRA conversion ladder

Ready to take this shit to the next level?

Let’s do an example, because I think it makes it way easier to understand.

Let’s pretend I’m ready to retire.

For the next five years, I’ll be living off my taxable investment accounts, cash in my emergency fund, and side hustle income.

But for now, in 2025, I’m going to determine what our annual expenses are: In our case, it’s about $90,000 per year.

I’d roll over my entire 401(k) into a Rollover (Traditional) IRA, then convert $30,000 of it into a Roth IRA. Why $30,000?

I’m glad you asked: As a married person filing taxes jointly, I receive a standard deduction of $30,000. If you’re single, the standard deduction is $15,000 in 2025.

That means I could—hold onto your seat—invest my money into my 401(k) tax-free with Traditional contributions, then strategically only convert (read: pony up and pay the taxes on an amount) up to the standard deduction so it’s (once again) tax-free (because remember, I have no other earned income this year!).

By doing this, I’ve completely avoided taxation on my contribution, growth, and withdrawal, AND avoided the 10% early use penalty.

The kicker is that you’ll need to plan for supplementing this income with income from another source (a taxable investing account, side hustle income, etc.), assuming your expenses are lower than $15,000 or $30,000.

The good news? Capital gains are taxed much more forgivingly than earned income, so as long as your total strategic conversions and withdrawals (described below) are less than $63,350 as a single person, you’re paying 0% taxes on the entire amount. YUP.

The math works out like this for a single person:

• $15,000 is your standard deduction, so you’ll pay no tax on your 401(k) > Traditional IRA > Roth IRA conversion chunk.

• $48,350 is the upper limit for the 0% tax bracket for capital gains taxes on withdrawals of growth from a taxable account.

• This means you’ll have $15,000 + $48,350 (or $63,350) in tax-free income. Remember what we said above? For couples, we need $90,000 in our plan, which means we’d convert $30,000 to Roth and withdraw up to $96,700 in capital gains tax free.

Because we only need $90,000, we can withdraw the full extent from the taxable account and reinvest what’s not spent, taking advantage of our 0% capital gains rate to step up our cost basis.

So the next year will pass in early retirement bliss: Sleeping in, working on passion projects, going to Mexico on a monthly basis—you know, the works.

By now, it’s the end of 2025, and it’s time to perform another conversion. Another conversion of $30,000 (or whatever the inflation-adjusted value is) from Traditional to Roth IRA.

Repeat this process in 2026, 2027, and 2028. At the beginning of 2029, my first $30,000 chunk will be available for spending, penalty-free. At the end of 2030, the money I converted in 2026 will be ready, and so on and so forth. Even after the $30,000 chunks start becoming available, you’ll still want to convert another chunk each year to continue the ladder in perpetuity.

Of course, you may have a fairly diversified pile of assets in all sorts of accounts, and you may still have some side hustles (that you do for fun) that produce some income.

Does this feel confusing?

It’s okay. In some ways, it’s intentionally confusing. We are exploiting a loophole in tax law, after all. There’s a much more in-depth breakdown in Chapter 6 of Rich Girl Nation.

The key takeaway (for now) is that your Traditional 401(k) is still an incredible place to stockpile as much money as possible, because you’ll be able to spend a little time learning and enacting this process when early retirement comes.

And trust me, your freedom will be worth it. You’ve probably spent way more time and effort learning shit that mattered far less, right? This is one bit of fancy logistical footwork that will enable you to leave the workforce, and I’d say that’s well worth it.