How Is Investing In 401k Saving Taxes?

How is investing in 401k saving tax? 401(k) is a retirement plan where employees can contribute part of their wages to. The contributions they make are known as pre-taxed funds. Thus, when you make $500 and contribute $100 to the 401(k) plan, you will only pay Federal Insurance Contributions Act (FICA) and Medicare withholding on the remaining $400, thus saving any tax on the $100 you contributed. You also will not have to have any withholding for federal income tax taken from your paycheck. This, of course, depends on the type of 401(k) plan that is set up with your company, and there are limitations on pre-tax contributions. Each plan is individual to the company and employees.

Of course, the government will collect their money in the end. When you retire, all of the pre-tax funds you contributed to the 401(k) are subject to income tax when you start receiving funds from the account. However, when you are working, you are likely to be in a higher tax bracket. When you retire, you have less income, therefore, you will actually be saving on income taxes in the long run.

On your W-2, your income will actually not show any pre-tax contributions you made to the 401(k) plan. If you earned $50,000 for the year but contributed $5,000 to your 401(k) plan, your W-2 will show you earned $45,000 and it will have the "Retirement Plan" box checked.

The Internal Revenue Service cannot double tax your income. You can defer portions of your income by investing in a 401(k) account. This is also true for self-employed individuals.

IRS Topic 424: 401(k) Plans