I have heard a lot of advice for young FIRE seekers to contribute to their 401k even if they are only in the 15% tax bracket. Here is why that might not be the best financial advice:
Once you start collecting Social Security (hopefully at age 70 for maximum benefit), the extra income from required minimum distributions (or necessary-for-cash-flow distributions) from your 401k may cause your marginal tax rate to go up to 26-30%. To understand why, you have to actually prepare a tax projection (a mini tax return). Social Security is either not taxed at all, taxed at 50% or taxed at 85%, depending on your other income.
Also keep in mind some of the income is out of your control – whether or not you want to, a portion of your 401k or IRA will be taxed to you every year starting at age 70 1/2. (There is talk of increasing that to age 72, but that law hasn’t passed yet as of the date of this post). Also, if you inherit an IRA, you are also required to be taxed on a portion of that every year REGARDLESS of your age.
If your taxable income (for a couple filing joint) is greater than $32,000, 50% of your Social Security above that amount is taxed. At $44,000 of income, 85% is taxed. The calculation is complicated; I suggest running a tax projection to get the exact figures if this is your situation. (Taxable “income” in this scenario means your adjusted gross income plus tax exempt interest income plus half of your Social Security benefits.)
Why would you want to take a 15% tax deduction when you will pay 25-30% on the back end? If you are able to empty your IRA by converting it to a Roth slowly over time before age 70 (ideal SS collection date), then this may make sense. However, in practice converting an IRA to a Roth will cost more than 15% in most cases.
This is why we rarely suggest contributing to a 401k if you are in the 15% tax bracket. Go Roth all the way – Roth IRA and/or Roth 401k, if available to you. If not, save in a taxable brokerage account.
Finding a fee-only financial advisor who can run these tax projections for you can be very valuable. A good CFP practitioner should provide much more advice than just investments. Taxes is only one area, but a very critical one. Make sure your advisor has a thorough understanding of income taxes!