Roth accounts include the Roth IRA and any Roth employer-sponsored accounts, such as a Roth 401(k). While HSAs aren’t technically Roth accounts, they can still be used as tax-free apex predators, like Roth accounts, when used for qualified medical expenses, so they fall into the same bucket. Following the Financial Order of Operations, you will maximize your Roth IRA and HSA, if you have the ability to do so, at Step 5. No matter your income or tax bracket, we believe it makes sense to maximize these tax-free accounts at Step 5. 

Step 6 is where it gets tricky. This is where you maximize your employer-sponsored retirement account, like a 401(k), 403(b), TSP, or other plan. About 93% of 401(k) plans offer a Roth option, in addition to the traditional pre-tax contribution option, so the majority of those with an employer-sponsored plan have a decision to make. Do you contribute to Roth or pre-tax?

If it makes sense for most to contribute to a Roth IRA over a pre-tax IRA, shouldn’t it also make sense to contribute to a Roth 401(k) over a pre-tax 401(k)? Not necessarily. Pre-tax IRAs have lower income phaseouts than Roth IRAs, which means if your income is high enough that contributing to a pre-tax IRA would make sense, you don’t have the ability to do so. However, high-income individuals can contribute to a Roth IRA through what is commonly referred to as the backdoor Roth strategy. It’s not necessarily always better for everyone to contribute to a Roth IRA over a pre-tax IRA, but those that would be better off contributing to a pre-tax IRA likely don’t have the ability because their income is too high. Plus, we believe in tax diversification of your assets, and even if you could construct a portfolio solely consisting of pre-tax accounts, it may not be wise.

The decision to contribute to a Roth 401(k) or a pre-tax 401(k) is a bit different. Both have no income phaseouts, so those with higher incomes have a choice. Choosing which account is more beneficial for you is actually quite simple: is your tax rate lower now than it will be in retirement? If so, contribute to Roth. Is your tax rate higher now than it will be in retirement? If so, contribute to pre-tax. It is impossible to know with certainty what your tax rate in retirement will be, which creates an advantage for Roth accounts: they create tax certainty.

Roth creates tax certainty

If you contribute to Roth retirement accounts, it doesn’t matter what your tax rate will be in retirement. It could be 10%, 50%, or 98%; no matter what, qualified Roth distributions will not be taxed at all (barring any unprecedented changes to Roth accounts by the government). This is a big advantage, even for those that could be looking at lower tax rates in retirement.

We are currently experiencing a period of historically low taxes on high-income individuals. The only extended period of time with lower rates on the highest income Americans was right before the Great Depression. We don’t like to speculate about future tax rates, but it is easy to look at a chart like this and see that tax rates could be higher in the future, even if your income stays the same. Roth accounts are a way to essentially pre-pay your taxes and lock-in whatever tax rate you are at now. That could be a great thing if you are uncertain whether your tax rate will remain the same in retirement.

Pre-tax could lower your tax burden

The obvious benefit of contributing to pre-tax retirement accounts is they lower your tax burden in the present, which could be more beneficial than delaying that tax benefit until retirement. It is very difficult to know with certainty if your tax rate will be higher or lower than it is now in retirement, so we created a rule of thumb to help you decide if contributing to pre-tax accounts is worth considering. We believe if your combined marginal income tax rate, including any local income tax rate, state income tax rate, and federal income tax rate, is above 30%, you should consider contributing to pre-tax employer retirement accounts instead of Roth. That’s a little confusing, so here’s an example:

Mary is single and makes $150,000 per year. Her highest federal income tax rate is 24%, and she lives in California where her highest state income tax rate is 9.3%. She does not pay any local income tax. Her combined marginal income tax rate is 33.3%, so it may make sense to consider contributing to pre-tax over Roth.

If your combined marginal income tax rate is under 25%, it may be worth considering contributing to Roth accounts over pre-tax accounts. If you are in-between 25% and 30%, take a closer look at your personal tax and retirement account situation. How much do you currently have in Roth accounts vs. pre-tax accounts? Will your taxable income be significantly higher or lower in retirement than it is now? How much are you concerned about the risk of tax rates rising in retirement?

Roth accounts are an incredible tax and retirement-planning tool that we believe everyone should take advantage of. However, high-income Americans especially should consider the advantages of contributing to pre-tax retirement accounts. It is very possible that the present tax benefit of contributing to pre-tax accounts outweighs the benefit of tax-free growth and tax-free distributions in retirement.

How to do a Mega Backdoor Roth

Many retirement savers only know about the standard salary deferral limit for 401(k) plans, which is $23,000 in 2024 for those under 50. Most don’t need to know how to contribute more, as only 15% of employees max out their workplace retirement plan. For some super savers, maybe Financial Mutants even, they max out their salary deferrals and look for additional places to invest. The salary deferral limit of $23,000, or $30,500 for those 50 and older, does not apply to after-tax 401(k) contributions. The annual additions limit applies to salary deferrals, employer matches, and after-tax contributions, and is $69,000 in 2024 (or $76,500 for the 50+ crowd).

What does this mean? Well, for someone under 50 that doesn’t get an employer match, it means they may be able t0 make $46,000 in after-tax contributions to their employer-sponsored plan. There is a big catch: not all employers allow after-tax contributions. Even if your employer allows after-tax contributions, they must allow in-plan Roth conversions in order for you to convert those after-tax contributions to Roth. If you have those magical ingredients, you may be able to build an enormous amount of Roth dollars for retirement.

Should I do a Mega Backdoor Roth?

I know what you’re thinking: forget about paying off high-interest debt, building an emergency fund, or contributing to a regular Roth IRA. I need to try out this Mega Backdoor Roth strategy now. Even if you do have the ability to build Roth dollars using the Mega Backdoor Roth strategy, it may not make sense to use it. For starters, there’s no reason to use this strategy if you can still contribute more money to a Roth IRA the old fashioned way or still have room left in your 401(k) salary deferral limit. There’s no advantage to building Mega Backdoor Roth dollars over Roth IRA or normal Roth 401(k) dollars, and executing the strategy is more complex. The Mega Backdoor Roth is part of Step 7 of the Financial Order of Operations for a reason. It is a maximization strategy and something to think about after your other financial ducks are in a row.

Even if you have the ability to use the Mega Backdoor Roth strategy and find yourself in Step 7 of the FOO, it still may not make sense for you. The average salary in the US is just over $60,000, which means if you max-out a Roth IRA, HSA, and 401(k), you would be contributing over half of your gross income into retirement accounts. That is a lot to ask for most Americans, to put it mildly, but also means it may not be necessary for most to maximize a 401(k), much less worry about advanced strategies like the Mega Backdoor Roth. If you have questions about how much you may need to invest for retirement, and what your retirement “number” is, check out our Know Your Number course.

The short answer to whether or not you should use the Mega Backdoor Roth strategy is “maybe.” If you aren’t sure, use the flowchart below to help you determine whether or not this strategy is right for you.

Can I do a Mega Backdoor Roth on my own?

So you’ve decided it makes sense for you to use the Mega Backdoor Roth strategy. Is this something you should attempt on your own or does it require the help of a professional? It is possible to attempt this strategy by yourself, but that doesn’t necessarily mean it is a great idea. The Mega Backdoor Roth is a complex strategy and, like the “normal” Backdoor Roth, there is a potential for unexpected tax consequences if something is not done correctly. Common pitfalls include not making sure your employer plan is set up correctly, not rolling your rollover balance quickly, or not knowing documentation requirements. If you have any doubts about your ability to effectively implement this strategy, or would feel better getting the help of a professional who has done it many times before, it may be worth reaching out to an experienced tax professional and/or a fee-only financial advisor.

For retirement savers that have already maximized their Roth IRA, HSA, 401(k), and other tax-advantaged retirement vehicles, the Mega Backdoor Roth strategy offers an incredible avenue to build even more tax-free dollars for retirement. However, this is a strategy that is best suited for high-income earners and Financial Mutants. Most Americans will never need to think about using the Mega Backdoor Roth strategy, and that’s fine! It is complex and not for the faint of heart, but the rewards can be tremendous.

Have questions about Roth IRAs and how Backdoor Roths work? Check out our Roth IRA Guide.

Learn everything you need to know about investing, including how to start, what to invest in, and when to prioritize paying off debt, at our Money Guy investing guide.

1. Get your employer match.

If you have an employer match, contributing enough to your retirement plan to get the full match should be your first priority when it comes to investing for retirement.

What if I don’t have an employer match?

If you don’t have an employer match, skip to the next retirement savings bucket (which is contributing to your Roth IRA and HSA).

What if I don’t need to contribute to get my employer match?

Some employers make contributions to your retirement plan no matter if you contribute or not. If your employer match does not require a contribution from you, skip to the next retirement buckets, Roth IRA and HSA.

What if my employer match is very generous?

Some employers offer very generous employer matches. Some are so generous that you may not be able to fully maximize the match right now. What do you do in this situation? Will you be stuck on maximizing your employer match forever?

Employer matching contributions are so powerful that you should prioritize getting every potential dollar you can, even if that means being “stuck” trying to maximize your employer match for a little while. Being “stuck” getting your employer match should be viewed as a blessing. Go give your employer a big sloppy bear hug!

What if my employer offers a discount on company stock?

Employee stock purchase plans, or ESPPs, may include a discount on company stock of up to 15%. Does this count as part of your employer match? The short answer is yes. Even though an ESPP discount typically isn’t as lucrative as a traditional employer match, it is still free money from your employer. Take full advantage of any discount on company stock you get before moving on to other retirement accounts.

2. Maximize your Roth IRA and/or HSA

Maximizing both your Roth IRA and HSA, if you are able to contribute to both, is the next step on your retirement investing journey.

Should I contribute to my Roth IRA or HSA first?

If you have access and are able to contribute to both, you may be wondering which you should prioritize. This is an often debated question on the show, and they are both amazing retirement savings vehicles, but the HSA may have a slight edge on the Roth IRA. Both are considered tax-free accounts, since qualified distributions for both are not taxed, but only the HSA allows contributions to enter pre-tax and qualified distributions to be taken tax-free. We are of the belief that most of us will spend a generous amount on medical expenses throughout our lives, which will allow you to use the HSA without ever being taxed on that money.

It is worth noting that HSAs aren’t as flexible as Roth IRAs. You can’t take out your contributions at any time, and to qualify for all tax advantages money can only be used for qualified medical expenses. However, after age 65, HSA dollars can be distributed for any reason (but will be taxed).

What if my income is too high to contribute to a Roth IRA?

If your income is too high to contribute to a Roth IRA, should you just skip it? No! Many high-income earners are able to still contribute to Roth IRAs using what are called backdoor Roth contributions. If you are able to use this strategy to contribute to a Roth IRA, do it. Check out the linked article for details about this strategy and how to implement it.

Should I really contribute to my Roth IRA before my Roth 401(k)? Aren’t they the same thing?

Depending on the quality of your 401(k) plan, your Roth 401(k) may be very similar to your Roth IRA. However, no matter if you have a great 401(k) plan, we still give Roth IRAs the slight edge. You can choose your Roth IRA provider, which means you can get access to a wider range of investments that may be less expensive. Roth IRA contributions can be withdrawn at any time, which gives you flexibility in very tough situations (although we believe you should avoid touching Roth dollars unless absolutely necessary). 401(k) plans do have some additional legal protections that Roth IRAs do not have. This may not be relevant for some, but read up on ERISA protections if they may come into play for you.

3. Maximize your employer-sponsored plan.

Maxing out your employer retirement plan, such as a 401(k), comes next. This means contributing the maximum you are able to, but does not include strategies like mega backdoor Roth contributions (that comes next).

What if I don’t have an employer-sponsored retirement plan?

Not all employers offer retirement plans, and if your employer is one that doesn’t, you may skip to the next retirement savings bucket (taxable brokerage account). However, you may have other options. If you work for a small employer, lobbying for a retirement plan could give your employer the extra nudge they need to add one. Chances are they have been considering it already, and if they know employees are interested, that might be the extra push they need.

If your employer won’t add a workplace retirement plan, there may be other options. Any self-employment income you have can be used to open and contribute to a self-employed retirement plan such as a solo 401(k). If you don’t work a traditional W-2 job or have side income, it can be a great opportunity to start your own retirement plan.

What if I don’t have the income to max out my employer-sponsored plan?

Maximizing your employer plan takes a lot of income. The overall goal is to invest 25% of your income for retirement; if you start early, less may be required, and if you are a late bloomer, you may need to contribute more. If you are contributing what you need to contribute for retirement, you may never need to maximize your employer plan, and that’s perfectly fine! In fact, getting your employer match and maximizing your Roth IRA and HSA may put you over the 25% investing benchmark. Check out our Know Your Number course for a deep-dive into how much you should invest to meet your retirement goals.

4. Hyperaccumulate for retirement.

If you reach this stage of saving for retirement, it’s likely your employer doesn’t offer a retirement plan or you have a high income. Most folks will be able to invest what they need for retirement without ever thinking about going above and beyond, and that is totally fine. For those who do need to invest more after going through the above steps, the next place you’ll turn will be mega backdoor Roth contributions, if your employer plan offers them, or taxable brokerage contributions.

Check out this video for more information about the mega backdoor Roth and how it works. If your employer plan is compatible, you may be able to build even more tax-free retirement assets. If you are unable to use this strategy or still need to invest more for retirement, consider utilizing a taxable brokerage account.

Brokerage accounts have no contribution limits and no restrictions on when money can be withdrawn or used. They have no special tax advantages like other retirement accounts and gains are taxed at long-term or short-term capital gains rates depending on the holding period of your assets.

Knowing exactly where to invest for retirement can be challenging since there are so many different types of plans and not everyone has the ability to contribute to every type of retirement plan. I hope this guide makes it a little more clear exactly where your next retirement dollar should go.

Is a Roth IRA an appropriate vehicle for an emergency fund? Since you can access basis penalty and tax-free, some advocate for using it as an emergency fund. Learn why Roth IRAs are so powerful and why they might be the perfect next step on your wealth building journey with our Roth IRA Guide.

If you are over the income limit to contribute to a Roth IRA and have access to an employer-sponsored 401(k) plan, do you even need to worry about contributing to a Roth IRA?

It’s not uncommon to reach retirement and have a large amount invested in pre-tax retirement accounts. What should you do in situations like this?

Want to know what to do with your next dollar? You need this free download: the Financial Order of Operations. It’s our nine tried-and-true steps that will help you secure your financial future.

When deciding between contributing to a traditional or Roth 401(k) based on your current tax situation, and for the Mega backdoor Roth conversion, you need to check if your employer’s plan allows it and consider other options if you are in a high tax bracket.

Want to know what to do with your next dollar? You need this free download: the Financial Order of Operations. It’s our nine tried-and-true steps that will help you secure your financial future.