I attended a seminar hosted by my employer on the new benefit they are rolling out. They are now allowing Roth 401k contributions as part of our 401k plan. Happy days, right? More options for people who want to have more options.

But little did I know that this will open up an entire new retirement strategy for us and will mean more tax-deferred or even tax-free growth on earnings on our money!

The Mega Backdoor Roth 401k Retirement Strategy

Most people will probably not consider putting more money in an after-tax 401k. There’s so many reasons why:

• Can’t max out pre-tax, so why even put in after-tax money?
• Living paycheck to paycheck
• Putting only the minimum match that the company puts in.

However, what I learned in the presentation blew my mind. If you want to retire early and your employer allows such a thing in your plan, this can definitely help you supercharge your retirement savings, and the money grows tax-deferred!

A small caveat though: not a lot of employers offer the same benefit that my current employer has when it comes to 401k retirement plans. This was just a change they did in 2018 that is definitely for the better. I’m just sharing this particular strategy with you guys in case you have the same plan and want to take advantage of it.

Remember: just because you read about a particular strategy on the internet does not mean it can necessarily apply to your situation. We do not put in our actual earnings on our blog, and this is all just hypothetical based on our own personal strategy.

Our After Tax 401k Retirement Maximization Strategy

Put the maximum pre-tax money in a Traditional 401k

There is a maximum contribution of $18,500 (as of 2018) pre-tax contribution that you are allowed per year. If you plan on retiring early, then there are ways to minimize your tax payments in the future by putting in the money in a Traditional 401k, and when you leave your job, converting it to a Traditional IRA and doing a Roth conversion ladder.

We also put in the maximum pre-tax contribution on traditional 401ks because for 2018, we put ourselves on a lower tax bracket because of this. This works out best if you are straddling between two tax brackets and want to save the additional tax that Uncle Sam demands of you.

Total pre-tax money: $37,000 (for two people) 

Put in the maximum Roth IRA Contribution

We qualified for the Roth IRA contribution because our AGI was below $189,000. Once we start earning more than that, we still qualify for partial Roth IRA contributions of a certain amount up to $199,000. However, if we are earning more than $199,000, then no more Roth IRA.

Roth IRAs are great because they can earn dividends and capital gains free and clear of any taxes. These are considered after-tax contributions but since we are a bit younger (early 30s), we still have the benefit of growing whatever we put on it tax-free.

Total Roth IRA contribution: $11,000 (for two people) 

The Health Savings Account (HSAs)

Peter still has his high deductible plan and is maxing it out. I recently switched to PPO for this year because of health reasons (i.e. might need to go see doctors more often), so I took myself out of the HSA picture.

HSAs are great – they are tax-deductible from your income, and they grow tax free as well. You can draw from it anytime as long as it is a qualified medical expense. However, you can draw from it free and clear once you reach 59 1/2 years old. It is such a great account where you can avoid paying taxes altogether that how could you not take advantage of it?

A caveat: this only works out if you are healthy and have no pre-existing medical conditions. Healthcare is expensive in this country, and without insurance, you are basically left to fend on your own (except if you qualify for Medicaid, Medicare, or enroll yourself in Obamacare plans).

Total HSA contribution $3,400 (for one person) 

The After-Tax Account

Did you know that if you have a 401(k) account, you are able to put in up to $55,000 maximum (including your pre-tax contributions amounting to $18,500) and the employer contributions. That’s extra money that you can put away for retirement that’s automatically deducted from your pay!

Let’s sweeten the deal even more, when your additional after-tax contributions can be transferred to a Roth 401(k), where the earnings are grown tax free, and the withdrawals (once qualified) are also tax free! You’re technically putting money in that’s already taxed anyway, so why not reap the benefits and keep the growth of your hard earned cash away from the government wanting more of their share of your hard-earned cash!

Our workplace recently offered this option this year, and my gosh, I was floored. Of course, I was all over it as I sat down and thought if it was indeed feasible: and it was. All it needs is for me to enroll a percentage of my after-tax contribution and on the day after our paycheck, calling the benefits hotline and asking them to do the in-plan conversion.

I’ll end up paying for any gains that I’ll get when they do the conversion, but since it is only a day after they executed the trade, it will be very negligible (i.e. during my first conversion, I lost less than $2 market value, so I essentially was doing a little bit of tax-loss harvesting).

If all goes well, I can be able to maximize this after-tax 401(k) account in such a way that all the earnings I put in this investment will grow tax-free! So if my Bond fund earns $20 in a month, I don’t have to pay around $3 (or 15% of capital gains). Multiply that by the number of years the investment will grow, and it can be significant!

Total After-Tax Contribution (excluding Employer Match 401k) : $16,000 (for one person)
**Peter is still trying to figure out if his employer has a plan like mine.

Total Retirement Contributions (tax-deferred/tax-free): $67,400!

$67,400 is a lot of money. To some people that is the salary of one person! Life is so much easier if there’s two of you striving for the same goals in retiring early and becoming financially independent. If we compound that $67,400 at a modest 4% growth per year, it will average around $2,700 per year of earnings! While that may not be enough to survive on, if we kept doing our retirement strategy for the next 10 years and contributing more and more to our retirement accounts, our earnings will be making enough for us both to live on!

Also, for our Roth accounts, we are free to withdraw the principal as we wish as it has already been taxed. If there are any emergencies or if we see a deal in real estate where we can use the cash, we’re free to take it out of our accounts (pending the 5 year hold, of course), without worries!

Ah the power of a high savings rate and of compounded interest

But wait, there’s more! If you still have extra cash coming in after the retirement strategy, you can put some more of them in taxable accounts! While the earnings will still be taxed, there are other investments that do not get taxed on the earnings at all too (Muni bonds for one). You can still put extra money that you have into other investments, fund an emergency fund (make sure it earns a decent amount of interest), 5% bank accounts (Insight or Netspend), 6% interest bank accounts (Mango), or use the spare money to start a new business (like start a blog).

If you invest your money, you end up making it back. It’s a cycle that keeps on giving: the more you want to keep investing the proceeds of your earnings, the more your invested money will grow and give back! Isn’t that better than just buying a new car or upgrading your house and its interiors?

**There’s a lot of confusing articles written about After-Tax 401k contributions, and I aim to put our two cents in by writing this article. If we screw up any of the rules, feel free to let us know!