Maximize Your 401(K) Savings: Understanding Pretax Investments

A 401(k) plan is an employer-sponsored retirement plan that allows employees to save for retirement in a tax-favored way. When you sign up for a 401(k) plan, you agree to have a percentage of your salary allocated to the plan’s investment accounts. Pre-tax dollars are used to contribute to a 401(k), and the contributions you make aren't included in your taxable income.

Tax benefits of 401(k)

A 401(k) plan is an employer-sponsored retirement plan that allows employees to save for retirement in a tax-favored way. When you sign up for a 401(k) plan, you agree to have a percentage of your salary allocated to the plan’s investment accounts. With tax-deferred 401(k) plans, you set aside part of your pay before federal and state income taxes are withheld, lowering your taxable income so you pay less income tax now. When you contribute to a 401(k), you are using pre-tax dollars to contribute to your 401(k), the contributions you make aren't included in your taxable income. This means that you can lower your tax bill.

There are several types of 401(k) plans available to employers - traditional 401(k) plans, safe harbor 401(k) plans and SIMPLE 401(k) plans. Different rules apply to each. For tax-favored status, a plan must be operated in accordance with the applicable rules. Therefore, it is important that the employer be familiar with the special rules that apply to its plan so the plan is administered in accordance with those rules. To qualify for the tax benefits available to qualified plans, a plan must both contain language that meets certain requirements (qualification rules) of the tax law and be operated in accordance with the plan’s provisions.

With a Roth 401(k), you make contributions with after-tax dollars. However, employers may make matching contributions on a pre-tax basis. Check with your employer about the options available for your plan, and be sure to talk with a tax specialist and/or investment professional to discuss your personal situation. Even contributing at the match threshold might not be enough to fully fund a secure retirement, and you might need to save in other ways to generate enough replacement income during retirement to maintain your standard of living. But that should never discourage you from saving what you can now. Everyone’s circumstances are different, and any contribution is better than none.

Pre-tax contributions lower taxable income

Pre-tax contributions to a 401(k) plan can help lower taxable income and reduce the tax bill for employees. When you contribute to a 401(k) plan, you set aside a portion of your salary before federal and state income taxes are deducted, which means that your contributions are not included in your taxable income. This can result in a lower taxable income and less income tax paid in the current year.

For example, if an employee contributes $100 to their 401(k) plan, they will pay less income tax in the current year because their taxable income will be reduced by $100. This can be particularly beneficial for employees who are in a high-income tax bracket or those who want to maximize their tax savings.

It's important to note that pre-tax contributions are different from after-tax contributions, which are typically made with Roth 401(k) plans. With a Roth 401(k), you contribute with after-tax dollars, meaning that you have already paid income tax on the money you contribute. However, Roth 401(k) plans offer tax-free growth and tax-free withdrawals in retirement, which can be advantageous in the long term.

In summary, pre-tax contributions to a 401(k) plan can help lower taxable income and reduce the tax bill for employees. It's essential to understand the differences between pre-tax and Roth 401(k) contributions and choose the plan that best suits your financial goals and circumstances.

Employer-sponsored retirement plans

Workplace retirement plans are among the most common investment vehicles Americans use to save for retirement. As of December 31, 2022, just over $26 trillion was held in employer-sponsored retirement plans, including traditional pension, profit sharing, and 401(k) plans. It’s critical to understand your 401(k) plan as you map out your savings journey into retirement.

A 401(k) plan is an employer-sponsored retirement plan that allows employees to save for retirement in a tax-favored way. When you sign up for a 401(k) plan, you agree to have a percentage of your salary allocated to the plan’s investment accounts.

There are several types of 401(k) plans available to employers - traditional 401(k) plans, safe harbor 401(k) plans and SIMPLE 401(k) plans. Different rules apply to each. For tax-favored status, a plan must be operated in accordance with the applicable rules. Therefore, it is important that the employer be familiar with the special rules that apply to its plan so the plan is administered in accordance with those rules.

With tax-deferred 401(k) plans, you set aside part of your pay before federal and state income taxes are withheld, lowering your taxable income so you pay less income tax now. With a tax-deferred 401(k), you don't pay taxes on the earnings as you make them every year. You will be taxed on the money you take from a tax-deferred 401(k) in your retirement years, but you will likely be taxed at a rate lower than when you were fully employed.

Employers may make matching contributions on a pre-tax basis. Check with your employer about the options available for your plan, and be sure to talk with a tax specialist and/or investment professional to discuss your personal situation. Even contributing at the match threshold might not be enough to fully fund a secure retirement, and you might need to save in other ways to generate enough replacement income during retirement to maintain your standard of living. But that should never discourage you from saving what you can now. Everyone’s circumstances are different, and any contribution is better than none.

Tax-deferred 401(k) earnings not taxed

K) plans are employer-sponsored retirement plans that allow employees to save for retirement in a tax-favored way. When you sign up for a 401(k) plan, you agree to have a percentage of your salary allocated to the plan’s investment accounts.

Traditional 401(k) plans are tax-deferred, meaning that elective deferrals and investment gains are not currently taxed and enjoy tax deferral until distribution. With a tax-deferred 401(k), you set aside part of your pay before federal and state income taxes are withheld, lowering your taxable income so you pay less income tax now. You will be taxed on the money you take from a tax-deferred 401(k) in your retirement years, but you will likely be taxed at a rate lower than when you were fully employed.

Employers may make matching contributions on a pre-tax basis. Check with your employer about the options available for your plan, and be sure to talk with a tax specialist and/or investment professional to discuss your personal situation.

Everyone’s circumstances are different, and any contribution is better than none. Even contributing at the match threshold might not be enough to fully fund a secure retirement, and you might need to save in other ways to generate enough replacement income during retirement to maintain your standard of living.

Workplace retirement plans are among the most common investment vehicles Americans use to save for retirement. As of December 31, 2022, just over $26 trillion was held in employer-sponsored retirement plans, including traditional pension, profit sharing, and 401(k) plans. It’s critical to understand your 401(k) plan as you map out your savings journey into retirement.

Roth 401(k) contributions with after-tax dollars

A 401(k) plan is an employer-sponsored retirement plan that allows employees to save for retirement in a tax-favored way. When you sign up for a 401(k) plan, you agree to have a percentage of your salary allocated to the plan’s investment accounts.

There are different types of 401(k) plans available to employers - traditional 401(k) plans, safe harbor 401(k) plans and SIMPLE 401(k) plans. Different rules apply to each. For tax-favored status, a plan must be operated in accordance with the applicable rules.

With a Roth 401(k), you make contributions with after-tax dollars. However, employers may make matching contributions on a pre-tax basis. Check with your employer about the options available for your plan, and be sure to talk with a tax specialist and/or investment professional to discuss your personal situation.

Even contributing at the match threshold might not be enough to fully fund a secure retirement, and you might need to save in other ways to generate enough replacement income during retirement to maintain your standard of living. But that should never discourage you from saving what you can now. Everyone’s circumstances are different, and any contribution is better than none.

Workplace retirement plans are among the most common investment vehicles Americans use to save for retirement. As of December 31, 2022, just over $26 trillion was held in employer-sponsored retirement plans, including traditional pension, profit sharing, and 401(k) plans. It’s critical to understand your 401(k) plan as you map out your savings journey into retirement.

Frequently asked questions