Are 401(k) Contributions Tax-Deductible?
401(k) plans are a popular retirement savings option that allows employees to contribute a portion of their salary before taxes are deducted. This means that contributions to a traditional 401(k) are tax-deductible, allowing individuals to reduce their taxable income for the year. This can lead to significant tax savings, particularly for those in higher tax brackets.
For example, if you earn $50,000 and contribute $5,000 to your 401(k), you only pay taxes on $45,000 of income for that year. It's important to note that while contributions lower your taxable income now, withdrawals made during retirement are taxed as ordinary income.
However, not all 401(k) plans have the same tax implications. Roth 401(k) plans allow for after-tax contributions, which means that you pay taxes on your income before contributing. In this case, withdrawals made in retirement, including qualified distributions, are tax-free.
Keep in mind that there are annual contribution limits set by the IRS, which may change yearly. For 2023, the limit is $22,500, with an additional catch-up contribution of $7,500 allowed for those aged 50 and older.
Ultimately, the tax implications of your 401(k) contributions depend on the type of plan you choose and your overall financial situation. It's advisable to consult with a financial advisor for personalized advice.