Still max 401k even if no income tax liability?

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mbasherp
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Still max 401k even if no income tax liability?

Post by mbasherp »

In running numbers for the year ahead, I realized that circumstances could combine to give our family enough tax credits in 2021 so that we would have zero (less than zero) income tax liability.

This made me wonder if maxing the 401k still makes sense, or perhaps if it’s better to only contribute what’s needed to bring us down to that 0% bracket, and direct the rest to our taxable account. Roth IRAs are always maxed.

The only thing I can think of is the tax drag on dividends or capital gains down the road, but we’re in the 0% bracket for capital gains and dividends. Am I missing anything else?
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retired@50
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Re: Still max 401k even if no income tax liability?

Post by retired@50 »

Will you continue to always be in the zero bracket?

If you hold a taxable account, and your income rises at some point, then the dividends would be taxed, albeit at the lower qualified dividends rate, but still taxed.

Regards,
If liberty means anything at all it means the right to tell people what they do not want to hear. -George Orwell
bugleheadd
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Re: Still max 401k even if no income tax liability?

Post by bugleheadd »

i would contribute at least the minimum to get company match

what about roth 401k? it sounds like you havent maxed that?
Afty
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Re: Still max 401k even if no income tax liability?

Post by Afty »

Can you contribute to a Roth 401k?
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mbasherp
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Re: Still max 401k even if no income tax liability?

Post by mbasherp »

Afty wrote: Mon Jan 18, 2021 2:35 pm Can you contribute to a Roth 401k?
Unfortunately no.
bugleheadd wrote: Mon Jan 18, 2021 2:34 pm i would contribute at least the minimum to get company match

what about roth 401k? it sounds like you havent maxed that?
Of course. We would still need to contribute some anyway to be in the 0% tax bracket (after credits).
Broken Man 1999
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Re: Still max 401k even if no income tax liability?

Post by Broken Man 1999 »

After contributing enough to the 401k match, OP could invest in tax- managed funds. Those type funds would temper the tax drag, to some degree.

Me, I would probably fill up the 401k plan anyway, as that tax-deferred growth is pretty sweet.

Of course having funds in a taxable account is nice when one faces large expenses, or to use as a tool for managing taxes when one is retired.

The most important thing is to get the funds invested, whereas the taxable or tax- deferred decision is the next most important decision, IMHO..

Broken Man 1999
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mbasherp
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Re: Still max 401k even if no income tax liability?

Post by mbasherp »

retired@50 wrote: Mon Jan 18, 2021 2:33 pm Will you continue to always be in the zero bracket?

If you hold a taxable account, and your income rises at some point, then the dividends would be taxed, albeit at the lower qualified dividends rate, but still taxed.

Regards,
I suppose this question is unanswerable, because it requires both knowing future income and future tax rates. I may hedge our bets and continue the 401k, but if it means leaving some nonrefundable tax credit space unused, it seems I’m paying an upfront price to hedge the future.
Jacotus
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Re: Still max 401k even if no income tax liability?

Post by Jacotus »

This seems like a small possibility if you cannot contribute to a Roth 401k, but do you have an after-tax 401k with the ability to rollover to Roth IRA?

Don't forget to do tax gain harvesting.
humblecoder
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Re: Still max 401k even if no income tax liability?

Post by humblecoder »

mbasherp wrote: Mon Jan 18, 2021 2:30 pm In running numbers for the year ahead, I realized that circumstances could combine to give our family enough tax credits in 2021 so that we would have zero (less than zero) income tax liability.

This made me wonder if maxing the 401k still makes sense, or perhaps if it’s better to only contribute what’s needed to bring us down to that 0% bracket, and direct the rest to our taxable account. Roth IRAs are always maxed.

The only thing I can think of is the tax drag on dividends or capital gains down the road, but we’re in the 0% bracket for capital gains and dividends. Am I missing anything else?
One thought would be to contribute enough to your Traditional 401k to get your tax credits and then put the rest into a Roth 401k. However, it sounds like you don't have access to a Roth 401k.

If it were me, I would put the rest into a taxable account.

If you are going to be in a higher tax bracket when you need the money, you'll likely pay more taxes when you withdraw from the 401k since you are paying taxes on the entire amount (not just the growth) and at the ordinary income rate. However, with the taxable account, you will only pay taxes on the gains and at the lower cap gains rate.
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Hector
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Re: Still max 401k even if no income tax liability?

Post by Hector »

I would not max 401k.
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goingup
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Re: Still max 401k even if no income tax liability?

Post by goingup »

You might be missing the behavioral aspects of 401k saving. For many, it is much easier to save via automatic payroll contributions. That money also stays locked in the 401k vault, unlike money in a taxable account which can be spent on homes, cars, etc. Another point in favor of 401K saving (that I have observed) is that some find it easier to stay the course in their 401k when markets tank, but get more skittish watching taxable accounts crater.

It’s hard to beat the benefits that come with setting up 401K contributions and letting that account grow year after year, tax deferred. :beer
babystep
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Re: Still max 401k even if no income tax liability?

Post by babystep »

It makes sense to only contribute up to the point so that you are in zero percent tax bracket and let the rest go towards the taxable.
Looks like Roth 401k is not an option and Roth IRA is already maxed out.
I also agree about your point with QDI and capital gains tax.

Diversification for the type of accounts could be a consideration. How big are the pre-tax, taxable and roth accounts? I would guess pre-tax is bigger than taxable and that would also bode well for keeping those additional dollars in the taxable.

There is one, less likely consideration that if 401k is not too big then any additional dollars contributed to 401k, could be converted to Roth without any tax liability such that you won't have to pay capital gains tax at all on all future growth. If additional dollars go to taxable then you may have to pay the capital gains tax.
international001
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Re: Still max 401k even if no income tax liability?

Post by international001 »

For the long term, it's still better to go pre-tax 401k at tax bracket 0% than to taxable. Of course, make your calculations for less than very long term.
Don't forget (backdoor) roth IRA before maxing 401k pre-tax.
Goldwater85
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Re: Still max 401k even if no income tax liability?

Post by Goldwater85 »

If you can snag the money 0% tax, do it.

Not guaranteed that a low tax drag fund in a taxable account comes out ahead, but bird in the hand.
ralph124cf
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Re: Still max 401k even if no income tax liability?

Post by ralph124cf »

Do you have a traditional (tax deductible) IRA. If so, you can convert the tIRA money to Roth, creating phantom taxable income which could be offset by the 401(k) contributions.

It all depends on what your savings and spending goals are.

Ralph
aristotelian
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Re: Still max 401k even if no income tax liability?

Post by aristotelian »

Do you have any idea what your tax bracket in retirement will look like? If 0-10%, I could see doing the 401k. Anything higher (eg you already have a high 401k balance and plan to keep maxing it in the future) I think I would do taxable.

Downside of taxable is tax drag on dividends during accumulation (2% *15% annually). Downside of 401k is gains taxed as income instead of LTCG. Tough to say which comes out ahead without a crystal ball. When in doubt you can do some of each.

The liquidity of taxable is also nice. If you aren't getting much benefit even in best case scenario for 401k, it may not be worth having funds tied up in a retirement account.
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mbasherp
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Re: Still max 401k even if no income tax liability?

Post by mbasherp »

babystep wrote: Mon Jan 18, 2021 3:52 pm Diversification for the type of accounts could be a consideration. How big are the pre-tax, taxable and roth accounts? I would guess pre-tax is bigger than taxable and that would also bode well for keeping those additional dollars in the taxable.
Our accounts are almost evenly split 1/3 each pre-tax (401k), Tax free (Roth IRA) and taxable. I won’t get too far into why, but while we both work, only one has a 401k. We got accustomed to treating taxable as a retirement account in lieu of 401k. Of course, it’s nice knowing it can also replace a car if needed. We wouldn’t touch it for things like a vacation or frivolous toys though.

We’re in our mid 30’s for reference... I realize this might sound like an odd situation, but we’re really just normal and reading on BH so much has gotten me constantly optimizing our dollars. If things shake out the way I expect, perhaps I should do a comprehensive post to get more detailed advice.
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Re: Still max 401k even if no income tax liability?

Post by babystep »

mbasherp wrote: Mon Jan 18, 2021 4:44 pm
babystep wrote: Mon Jan 18, 2021 3:52 pm Diversification for the type of accounts could be a consideration. How big are the pre-tax, taxable and roth accounts? I would guess pre-tax is bigger than taxable and that would also bode well for keeping those additional dollars in the taxable.
Our accounts are almost evenly split 1/3 each pre-tax, Tax free and taxable. I won’t get too far into why, but while we both work, only one has a 401k. We got accustomed to treating taxable as a retirement account in lieu of 401k.

We’re in our mid 30’s for reference... I realize this might sound like an odd situation, but we’re really just normal and reading on BH so much has gotten me constantly optimizing our dollars.
A BH in mid 30s and knowing this level of details will likely will end-up in the higher tax bracket in retirements. I would go for taxable for additional dollars instead of 401k.
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mbasherp
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Re: Still max 401k even if no income tax liability?

Post by mbasherp »

aristotelian wrote: Mon Jan 18, 2021 4:40 pm Do you have any idea what your tax bracket in retirement will look like? If 0-10%, I could see doing the 401k. Anything higher (eg you already have a high 401k balance and plan to keep maxing it in the future) I think I would do taxable.

Downside of taxable is tax drag on dividends during accumulation (2% *15% annually). Downside of 401k is gains taxed as income instead of LTCG. Tough to say which comes out ahead without a crystal ball. When in doubt you can do some of each.

The liquidity of taxable is also nice. If you aren't getting much benefit even in best case scenario for 401k, it may not be worth having funds tied up in a retirement account.
Being in our 30’s, I couldn’t possibly guess our tax bracket in retirement. So much could change. If laws don’t, I would guess we would be in 12% bracket, as we were until 2020.

I understand the tax drag on dividends part, but since we’re currently at a 0% rate for those too, that’s what got the gears turning.
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Re: Still max 401k even if no income tax liability?

Post by aristotelian »

mbasherp wrote: Mon Jan 18, 2021 5:05 pm
aristotelian wrote: Mon Jan 18, 2021 4:40 pm Do you have any idea what your tax bracket in retirement will look like? If 0-10%, I could see doing the 401k. Anything higher (eg you already have a high 401k balance and plan to keep maxing it in the future) I think I would do taxable.

Downside of taxable is tax drag on dividends during accumulation (2% *15% annually). Downside of 401k is gains taxed as income instead of LTCG. Tough to say which comes out ahead without a crystal ball. When in doubt you can do some of each.

The liquidity of taxable is also nice. If you aren't getting much benefit even in best case scenario for 401k, it may not be worth having funds tied up in a retirement account.
Being in our 30’s, I couldn’t possibly guess our tax bracket in retirement. So much could change. If laws don’t, I would guess we would be in 12% bracket, as we were until 2020.

I understand the tax drag on dividends part, but since we’re currently at a 0% rate for those too, that’s what got the gears turning.
I would do taxable. No sense in deferring tax if your tax rate in retirement is likely higher. That said, you can always do some of each to hedge.
TSC15
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Re: Still max 401k even if no income tax liability?

Post by TSC15 »

I would max out the 401K contribution. Estimate the dividend payout for the year in your taxable account. If your income still falls below the zero tax bracket, I will sell and then buy back your taxable funds to raise the cost basis. This will minimize future capital gain when selling or allow for tax loss harvesting.
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teen persuasion
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Re: Still max 401k even if no income tax liability?

Post by teen persuasion »

mbasherp wrote: Mon Jan 18, 2021 2:30 pm In running numbers for the year ahead, I realized that circumstances could combine to give our family enough tax credits in 2021 so that we would have zero (less than zero) income tax liability.

This made me wonder if maxing the 401k still makes sense, or perhaps if it’s better to only contribute what’s needed to bring us down to that 0% bracket, and direct the rest to our taxable account. Roth IRAs are always maxed.

The only thing I can think of is the tax drag on dividends or capital gains down the road, but we’re in the 0% bracket for capital gains and dividends. Am I missing anything else?
Are these credits refundable, or nonrefundable?

We burn a lot of nonrefundable credits just to get our refundable credits as high as possible through 401k and SIMPLE IRA and HSA contributions. We could opt to use some of the nonrefundable credits to Roth convert or contribute to Roth 401k at zero tax cost, but it seems better to maximize our essentially negative taxes and use that additional income to make additional savings to Roth IRAs.

Part of our math involves state tax credits that partially match federal credits, and are also refundable. Another part of our math involves a target for our AGI for college financial aid purposes.

But as long as we are eligible for CTC ($1400 refundable, 33% state match on first $1k), AOTC ($1k refundable, state $200), and EITC (up to $5828 w/ 2 kids, refundable, 30% state match), we try to get the most we can out of them.
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Re: Still max 401k even if no income tax liability?

Post by FiveK »

mbasherp wrote: Mon Jan 18, 2021 2:36 pm We would still need to contribute some anyway to be in the 0% tax bracket (after credits).
mbasherp wrote: Mon Jan 18, 2021 5:05 pm I couldn’t possibly guess our tax bracket in retirement. So much could change. If laws don’t, I would guess we would be in 12% bracket, as we were until 2020.
teen persuasion wrote: Mon Jan 18, 2021 7:33 pm Are these credits refundable, or nonrefundable? ...
teen persuasion's question is important. Getting money back due to refundable credits does not mean that one has a 0% marginal tax rate. That's the rate that matters, and it is not necessarily the same as the nominal tax bracket. Have you calculated the marginal tax rate on various amount of 401k contributions?

Taking your best guess (e.g., 12%), or other back-of-the-envelope approach to Estimating your future marginal tax rate is a reasonable thing to do.

Given the two rates above, you can make a defensible choice for traditional vs. taxable (which, if you further assume no annual taxes on dividends, etc., becomes very similar to traditional vs. Roth).

Does that make sense?
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mbasherp
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Re: Still max 401k even if no income tax liability?

Post by mbasherp »

teen persuasion wrote: Mon Jan 18, 2021 7:33 pm
Are these credits refundable, or nonrefundable?
Some of both. But the scenario which we may possibly create is buying a new car (PHEV with $7500 non refundable credit). If not for that, I would just be taking the foreign tax credit and child tax credit... and possibly the dependent care credit depending on pending legislation.
qwertyjazz
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Re: Still max 401k even if no income tax liability?

Post by qwertyjazz »

Can you do an in service withdrawal the 401k and then roll into trad IRA and then convert to Roth? Not sure if benefits to withdrawal due to COVID might also apply
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Re: Still max 401k even if no income tax liability?

Post by celia »

Broken Man 1999 wrote: Mon Jan 18, 2021 2:44 pm Me, I would probably fill up the 401k plan anyway, as that tax-deferred growth is pretty sweet.
goingup wrote: Mon Jan 18, 2021 3:47 pm It’s hard to beat the benefits that come with setting up 401K contributions and letting that account grow year after year, tax deferred. :beer
international001 wrote: Mon Jan 18, 2021 4:25 pm For the long term, it's still better to go pre-tax 401k at tax bracket 0% than to taxable.
I can't fathom why someone would pass up a known 0% tax rate for something going to taxable in exchange for an unknown future tax rate applied to not only the tax-deferred contribution but lots of growth with it! The future 401K can end up with a large balance and RMDs that can push you into an even higher tax bracket. It would be unlikely that the tax-deferred RMD would be taxed at 0% if it is bigger than the standard deduction (at withdrawal time).
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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teen persuasion
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Re: Still max 401k even if no income tax liability?

Post by teen persuasion »

mbasherp wrote: Mon Jan 18, 2021 9:25 pm
teen persuasion wrote: Mon Jan 18, 2021 7:33 pm
Are these credits refundable, or nonrefundable?
Some of both. But the scenario which we may possibly create is buying a new car (PHEV with $7500 non refundable credit). If not for that, I would just be taking the foreign tax credit and child tax credit... and possibly the dependent care credit depending on pending legislation.
So it appears only the CTC is at least partially refundable. Would the 401k contributions make up to $1400 refundable to you?

Beyond that point, there's not as much point to putting it in the 401k, due to future taxation at ordinary tax rates, unless you'd be retiring early and can do Roth conversions at zero tax cost. But in this case taxable savings are also useful, as the LTCG zero bracket is larger than the ordinary income zero bracket.
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Re: Still max 401k even if no income tax liability?

Post by humblecoder »

celia wrote: Tue Jan 19, 2021 3:53 am
Broken Man 1999 wrote: Mon Jan 18, 2021 2:44 pm Me, I would probably fill up the 401k plan anyway, as that tax-deferred growth is pretty sweet.
goingup wrote: Mon Jan 18, 2021 3:47 pm It’s hard to beat the benefits that come with setting up 401K contributions and letting that account grow year after year, tax deferred. :beer
international001 wrote: Mon Jan 18, 2021 4:25 pm For the long term, it's still better to go pre-tax 401k at tax bracket 0% than to taxable.
I can't fathom why someone would pass up a known 0% tax rate for something going to taxable in exchange for an unknown future tax rate applied to not only the tax-deferred contribution but lots of growth with it! The future 401K can end up with a large balance and RMDs that can push you into an even higher tax bracket. It would be unlikely that the tax-deferred RMD would be taxed at 0% if it is bigger than the standard deduction (at withdrawal time).
+1

It makes little sense to me to defer taxes on current income into the future by contributing to a Traditional 401k today when you are in the 0% tax bracket today. At best you come out even vs taxable. At worst, you are now paying a higher tax rate both on your earnings AND your contribution on your 401k withdrawals. Whereas taxable you are only paying taxes on your earnings/cap gains.

And for those touting tax deferred growth, if the OP is in the 0% tax bracket, he/she is getting tax-deferred growth in a taxable account on any dividends (remember - 0% tax bracket) and cap gains are also tax deferred in a taxable account.

Honestly, there is little financial upside to continuing to contribute to a Traditional 401k in this scenario. Yes future tax code can change, but TODAY it is known that the person is in the 0% tax bracket. The OP should take advantage of that situation now.
02nz
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Re: Still max 401k even if no income tax liability?

Post by 02nz »

Traditional 401k contributions do not make sense in the 0% bracket unless they can help you get a tax credit.

In addition to the earlier suggestion about Roth conversions (if you have a traditional/rollover IRA), you may also want to consider tax-gain harvesting if you have a taxable account, since you'd be locking in the gains at a 0% LTCG rate.
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Watty
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Re: Still max 401k even if no income tax liability?

Post by Watty »

mbasherp wrote: Mon Jan 18, 2021 2:30 pm ....enough tax credits in 2021 so that we would have zero (less than zero) income tax liability.

Am I missing anything else?
Are the tax credits refundable?

Can your or a spouse do Roth conversions?

Your state taxes may complicate the calculation but Roth conversions could be used to make sure that you get to use any non-refundable tax credits and get to the point where you have used up all the 0% federal tax bracket.

We cannot discuss proposed legislation here but be aware that there has been talk of increasing the child tax credit for a year so be be sure to Google that to see how that might impact your plans.
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mbasherp
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Re: Still max 401k even if no income tax liability?

Post by mbasherp »

02nz wrote: Tue Jan 19, 2021 9:56 am Traditional 401k contributions do not make sense in the 0% bracket unless they can help you get a tax credit.

In addition to the earlier suggestion about Roth conversions (if you have a traditional/rollover IRA), you may also want to consider tax-gain harvesting if you have a taxable account, since you'd be locking in the gains at a 0% LTCG rate.
We don’t have anything that can be converted to Roth but we do tax gain harvest annually.
international001
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Re: Still max 401k even if no income tax liability?

Post by international001 »

humblecoder wrote: Tue Jan 19, 2021 9:49 am
celia wrote: Tue Jan 19, 2021 3:53 am
Broken Man 1999 wrote: Mon Jan 18, 2021 2:44 pm Me, I would probably fill up the 401k plan anyway, as that tax-deferred growth is pretty sweet.
goingup wrote: Mon Jan 18, 2021 3:47 pm It’s hard to beat the benefits that come with setting up 401K contributions and letting that account grow year after year, tax deferred. :beer
international001 wrote: Mon Jan 18, 2021 4:25 pm For the long term, it's still better to go pre-tax 401k at tax bracket 0% than to taxable.
I can't fathom why someone would pass up a known 0% tax rate for something going to taxable in exchange for an unknown future tax rate applied to not only the tax-deferred contribution but lots of growth with it! The future 401K can end up with a large balance and RMDs that can push you into an even higher tax bracket. It would be unlikely that the tax-deferred RMD would be taxed at 0% if it is bigger than the standard deduction (at withdrawal time).
+1

It makes little sense to me to defer taxes on current income into the future by contributing to a Traditional 401k today when you are in the 0% tax bracket today. At best you come out even vs taxable. At worst, you are now paying a higher tax rate both on your earnings AND your contribution on your 401k withdrawals. Whereas taxable you are only paying taxes on your earnings/cap gains.

And for those touting tax deferred growth, if the OP is in the 0% tax bracket, he/she is getting tax-deferred growth in a taxable account on any dividends (remember - 0% tax bracket) and cap gains are also tax deferred in a taxable account.

Honestly, there is little financial upside to continuing to contribute to a Traditional 401k in this scenario. Yes future tax code can change, but TODAY it is known that the person is in the 0% tax bracket. The OP should take advantage of that situation now.
I said long term. Imagine 1000 years
If you invest on taxable, eventually your dividends will be so high that they will be taxed (at least at 15%)

But, of course, make your numbers. Consider timing and possibility than in a few years you don't get all those credits.
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