Yes, most 401(k) contributions are pre-tax, which means they lower the income you report to the IRS

When you contribute to a traditional 401(k), the money comes out of your paycheck before federal income tax is calculated. Your employer subtracts the contribution amount, then calculates tax on what remains. This reduces your taxable income for the year — the number the IRS uses to determine how much tax you owe.

If you earn $60,000 and contribute $7,000 to a traditional 401(k), you report $53,000 as taxable income instead. You pay income tax only on that $53,000. The $7,000 sits in your account untouched by federal tax until you withdraw it in retirement, when you will owe tax on it then.

This is different from a Roth 401(k), where contributions are made with after-tax dollars — you pay tax on the money now, and withdrawals in retirement are tax-free. Most people with a 401(k) at work have the traditional version unless they specifically chose Roth.

Key Takeaways

  • Traditional 401(k) contributions reduce your taxable income in the year you make them, lowering the federal income tax you owe that year.
  • The money grows tax-free inside the account, but you pay income tax on withdrawals after age 59½.
  • Roth 401(k) contributions are made with after-tax dollars and do not reduce your current taxable income, but withdrawals in retirement are tax-free.
  • Your employer may also contribute to your 401(k) as a match, and those employer contributions are also pre-tax.
  • State income tax treatment varies — some states do not tax 401(k) contributions, while others do.

How the pre-tax deduction works on your paycheck

Your employer calculates your paycheck in steps. First, they subtract your 401(k) contribution from your gross pay. Then they calculate federal income tax, Social Security tax, and Medicare tax on the reduced amount. This is why the pre-tax contribution saves you money when ready — you pay less tax in the current year.

If your tax bracket is 22 percent, a $7,000 contribution saves you roughly $1,540 in federal income tax that year. That is money that stays in your account instead of going to the IRS. The exact savings depends on your tax bracket, which depends on your total income.

Social Security and Medicare taxes (called FICA taxes) are different. You still pay these on 401(k) contributions — they are not pre-tax for those purposes. Only federal income tax and, in most states, state income tax are reduced by the contribution.

The difference between traditional and Roth 401(k) contributions

A traditional 401(k) reduces your taxable income now. You pay tax later, when you withdraw the money. This makes sense if you expect to be in a lower tax bracket in retirement, or if you want to reduce your taxable income this year.

A Roth 401(k) does the opposite. You pay tax on the contribution now, at your current rate. The money grows tax-free, and you pay no tax on withdrawals in retirement. This makes sense if you expect to be in a higher tax bracket later, or if you want to lock in your current tax rate.

Some employers offer both options. You can split your contribution between them — for example, $4,000 to traditional and $3,000 to Roth. Only the traditional portion reduces your taxable income for the year.

Contribution limits and how they affect your taxes

The IRS sets an annual limit on how much you can contribute to a 401(k). For 2024, the limit is $23,500 for people under 50, and $31,000 for people 50 and older (the extra $7,500 is called a catch-up contribution). These limits explore to your own contributions, not to employer matches.

The full amount of your contribution, up to the limit, reduces your taxable income if it is going to a traditional 401(k). If you contribute the maximum $23,500 to a traditional 401(k), you reduce your taxable income by $23,500 that year.

If you have both a 401(k) and an IRA, the limits are separate. Your 401(k) contributions do not count against your IRA limit, and vice versa. However, if you have a traditional IRA, the tax deduction for IRA contributions may be limited if you also have a 401(k) — this depends on your income and filing status.

What happens when you withdraw the money

Traditional 401(k) withdrawals are taxed as ordinary income. If you withdraw $50,000 in retirement, that $50,000 is added to your other income for the year, and you pay tax on the total at your current rate. This is why the pre-tax contribution is a deferral, not a permanent tax break — you are moving the tax bill to later, not eliminating it.

You can begin withdrawing from a traditional 401(k) without penalty at age 59½. Withdrawals before that age are subject to a 10 percent early withdrawal penalty, plus income tax on the amount withdrawn. Some exceptions exist — for example, if you are disabled or face a financial hardship — but they are narrow.

At age 73, you must begin taking required minimum distributions (RMDs) from a traditional 401(k). The IRS calculates the minimum amount based on your age and account balance. You must withdraw at least that amount each year and pay tax on it, whether you need the money or not.

State income tax and 401(k) contributions

Most states that have an income tax also treat 401(k) contributions as pre-tax, meaning they reduce your state taxable income the same way they reduce your federal taxable income. However, some states have different rules.

Pennsylvania and Illinois do not tax income from pensions or retirement accounts, but they do tax 401(k) contributions in the year you make them — the contribution itself is not deductible at the state level. A few other states have similar rules. If you live in one of these states, your 401(k) contribution reduces your federal taxable income but not your state taxable income.

If you move to a different state after retiring, the tax treatment of your withdrawals may change. Some states tax retirement income heavily, while others do not tax it at all. This is a long-term consideration, but it is worth understanding before you retire.

Employer matching and how it affects your taxes

Many employers offer a 401(k) match — they contribute money to your account based on how much you contribute. A common match is 50 percent of the first 6 percent of your salary. If you earn $60,000 and contribute $3,600 (6 percent), your employer contributes $1,800 (50 percent of $3,600).

Employer contributions are always pre-tax. They reduce your taxable income just like your own contributions do. The $1,800 match in the example above lowers your taxable income by $1,800, even though you did not contribute it yourself.

This is one reason to contribute enough to get the full match — the employer contribution is when ready, tax-free growth in your account. If your employer matches 50 percent of the first 6 percent and you only contribute 3 percent, you are leaving half the match on the table.

Frequently Asked Questions

Do I have to pay Social Security and Medicare tax on 401(k) contributions?

Yes. While 401(k) contributions reduce your federal income tax, you still pay Social Security tax (6.2 percent) and Medicare tax (1.45 percent) on the contribution amount. Only federal income tax and state income tax (in most states) are avoided through the pre-tax contribution.

Can I change from traditional to Roth 401(k) mid-year?

Yes. You can change your election at any time, and the change takes effect on your next paycheck. If you switch from traditional to Roth halfway through the year, your contributions before the switch are pre-tax, and your contributions after the switch are after-tax. You will report both on your tax return.

What if my employer does not offer a 401(k)?

You can open a traditional IRA instead, and contributions may be tax-deductible depending on your income and whether you have access to a 401(k) at work. The rules are more complex if you have both a 401(k) and an IRA, so check the IRS rules for your situation.

Do I report my 401(k) contribution on my tax return?

Your employer reports it on your W-2 form in Box 12. You do not need to list it separately on your tax return — the pre-tax reduction is already reflected in your W-2 wages. If you made a Roth 401(k) contribution, that appears on your W-2 as well, but it does not reduce your taxable wages.

What if I withdraw money from my 401(k) before retirement?

You pay income tax on the withdrawal plus a 10 percent early withdrawal penalty, with some exceptions. The penalty applies to the pre-tax portion of the withdrawal. If you withdraw $10,000 before age 59½, you owe income tax on the full $10,000 plus a $1,000 penalty, unless an exception applies.