Keep in mind that you are postponing, not avoiding, paying income taxes on your Pre-Tax Elective Contributions to the Plan. When you receive a withdrawal or distribution from the Plan, your Pre-Tax Elective Contributions, adjusted for earnings and loss, will be taxable income unless you roll it over to an IRA or another plan.
Even though your Pre-Tax Elective Contributions to the Plan are income tax-free when made, you still pay Social Security taxes on your contributions. Note - some states may impose state income tax on your contributions. When you make Designated Roth Contributions you pay income tax on your contributions before they go into the 401(k) Plan. And, if your Designated Roth Contributions are not withdrawn for at least five years after your first Designated Roth Contribution is made and the distribution is made after you have attained age 59 ½, or incurred a disability or died, then any earnings on the contributions will not be taxed.
Contributing to the 401(k) Plan doesn't reduce your other pay related benefits (such as the Defined Benefit Plan). These benefits are based on your pay before your contributions to the 401(k) Plan are deducted.
Your Pre-Tax Elective Contributions to the 401(k) Plan are made with pre-tax dollars. Each dollar you contribute lowers your taxable income for the applicable year, so you end up lowering the amount of income tax that you currently pay.
Designated Roth Contributions and After-Tax Contributions are made with after-tax dollars. This means these contributions are included in your taxable income in the current year, but they are not taxed again when they are distributed from the 401(k) Plan.
Here's an example of how saving with Pre-Tax Elective Contributions affects your take home pay, when compared to saving with Designated Roth Contributions or After-Tax Contributions. Let's say you:
The chart below compares the impact on your current income of making Pre-Tax Elective Contributions to making Designated Roth or After-Tax Contributions.
| Roth or After-Tax Contributions | Pre-Tax Elective Contributions | |
| Annual Compensation | $60,000 | $60,000 |
| Personal Exemption | - (3,800) | - (3,800) |
| Standard Deduction | - (6,100) | - (6,100) |
| 6% Elective Contribution (pre-tax) | - 0 | - (3,600) |
| Taxable Income | 50,100 | 46,500 |
| Federal Income Tax (21%) | - (10,521) | - (9,765) |
| Income after taxes | 39,579 | 36,735 |
| 6% After-Tax Contribution | - (3,600) | - 0 |
| Disposable Income | $35,979 | $36,735 |
The difference in disposable income due to tax savings is an additional $756 with Pre-Tax Elective Contributions.
The rules governing income tax consequences of withdrawals and distributions from plans like the 401(k) Plan are complex. This discussion is intended only to highlight general tax information. You should consult a professional tax advisor on matters pertaining to tax laws and how they affect you.
Your Pre-Tax Elective Contributions, as well as any investment returns, are not taxed for as long as they remain in the 401(k) Plan. This results in increased savings because the money that would have gone toward paying taxes on investment returns stays in your account where it can continue to grow. Although your After-Tax Contributions and Designated Roth Contributions are taxed, investment returns on those contributions are not taxed while in the 401(k) Plan.
|
Issue |
Pre-Tax Elective Contributions |
Designated Roth Contributions |
After-Tax Contributions |
|
Payroll deductions and tax withholding |
Contributions are deducted from your earnings before federal and most state and local income taxes are withheld (no such taxes are withheld from your pay on these contributions). |
Contributions are deducted from your earnings after income taxes are withheld. |
Contributions are deducted from your earnings after income taxes are withheld. |
|
Impact on current-year income tax |
Contributions reduce your current-year taxable income. |
Contributions have no effect on your current-year taxable income. |
Contributions have no effect on your current-year taxable income. |
|
Impact on current take-home pay |
You have more take-home pay than if you contributed the same percentage of eligible earnings to a Designated Roth account because income tax is not withheld on Pre-Tax Elective Contributions. |
You have less take-home pay than if you elected the same percentage of eligible earnings for Pre-Tax Elective Contributions because income tax is withheld on Designated Roth Contributions. |
You have less take-home pay than if you elected the same percentage of eligible earnings for Pre-Tax Elective Contributions because income tax is withheld on After-Tax Contributions. |
|
Income tax on distribution of 401(k) account (if not rolled over) |
You will pay tax on all Pre-Tax Elective Contributions and any investment earnings. |
You will not pay tax on the value of Designated Roth Contributions (since you already paid the tax). You will not pay tax on any investment earnings if certain conditions are met; see "When Income Taxes are Due" for a list of conditions. |
You will not pay tax on the value of After-Tax Contributions (since you already paid the tax).
You will pay tax on any investment earnings. |
|
Withdrawal restrictions |
Restrictions on withdrawal before age 59 ½. |
Restrictions on withdrawal before age 59 ½. |
Restrictions on withdrawal before age 59 ½. |
