Are 401(k) contributions tax deductible?

Participating in your employer's 401(k) plan is one of the best ways to save for retirement. But you may wonder: Are 401(k) contributions tax deductible? Not exactly. However, whether you contribute to a traditional or Roth 401(k) makes a big difference. Because contributions to a traditional 401(k) are deducted pre-tax from your salary, they ultimately reduce your taxable income. Meanwhile, contributions to a Roth 401(k) are made with after-tax dollars, so you don't get an immediate tax advantage. Let's break it down.

This article will cover:

• How traditional 401(k) contributions affect taxes
• How are employer matching contributions taxed?
• Reporting 401(k) contributions on your tax return
• How does the Saver's Credit affect taxes?
• How do Roth 401(k) contributions get taxed?

If you're contributing to a traditional 401(k), the money you contribute comes directly from your paycheck before taxes are taken out. That's what we mean by "pre-tax dollars"—you won't pay taxes on that money in the year you earn it. So if you're making $60,000 a year and contribute $6,000 to your 401(k), you'll only be taxed on $54,000 of your income.

Instead, taxes on a traditional 401(k) kick in when you retire, reach required mimum distribution (RMD) age (73 as of October 2024), or withdraw early (which can incur a 10% penalty if it's before age 59½). That's when your withdrawals are considered taxable income. This setup allows you to save more now and defer taxes until later, when you're retired and hopefully in a lower tax bracket.

The aim is to prioritize paying your tax bill during the season of life when you'll have less income and, therefore, a lower tax burden. This works differently than Roth accounts, which we'll talk about later.

Employer matches offer a powerful opportunity to increase your 401(k) contributions without straining your monthly budget. Essentially, your employer adds extra money to your retirement savings on top of what you contribute.

It's generally recommended to contribute to your 401(k) up to the available match from your employer, since that's free money, essentially. Once you're contributing significantly to your 401(k), you may realize that there are opportunities to max out those contributions or invest in other ways.

Like your contributions, employer contributions aren't taxed on the front end. But when you take distributions from these accounts in retirement, you'll effectively pay income taxes on that money and whatever growth it may have experienced.

Good news: You usually don't have to take any extra steps to report traditional 401(k) contributions on your tax return. Your employer handles all of that for you. When you get your W-2 form at the end of the year, it will already show the total amount you contributed to your 401(k) in Box 12 (labeled "D" for 401(k) contributions). This amount is subtracted from your wages, and it's automatically factored into your taxable income for the year.

So, there's no need for you to track or report it separately unless you made contributions to other retirement plans. The process is seamless, and your W-2 will reflect everything accurately.

And don't forget, employer matches will show up on your 401(k) statement, but they won't show up on your W-2 because they aren't part of your taxable income for the year. That's just a technicality—you still get to enjoy the benefits of that money growing tax-deferred.

The Retirement Savings Contributions Credit, otherwise known as the Saver's Credit, gives you a tax credit for contributing to your 401(k) when you make a low or moderate income. There are some specific eligibility requirements for this credit, including being at least 18, not a student and not being claimed as anyone's dependent.

For 2024, the income limits for the Saver's Credit are:

• $36,000 for individuals.
• $72,000 for married couples filing jointly.

For 2025, the income limits are:

• $39,500 for individuals.
• $79,000 for married couples filing jointly.

So, if you meet these requirements, not only will you lower your taxable income by contributing to your 401(k), but you also could lower your taxes even more by receiving between 10% and 50% of your contribution to your 401(k) back from the Saver's Credit.

Contributions to Roth 401(k)s are similar to traditional 401(k)s in the sense that neither are truly tax deductible. However, they're different in that they don't lower your taxable income or provide a tax break in the contribution stage at all. Instead, you pay taxes upfront and withdraw your money tax-free in retirement.

Roth accounts delay gratification, but a doubly appealing tax benefit in your retirement years. For example, say you contribute $1,000 to a traditional 401(k). You later will pay taxes on both that $1,000 you eventually withdraw in retirement and anything it gains through market growth before you retire. So something like $2,000 might be taxed in total. With a Roth 401(k), you pay taxes on just the upfront $1,000. Both the growth and the principal are withdrawn tax-free in retirement.

You might choose a Roth account if you feel that you'll have a lower tax bill now than you would during retirement. Because Roth contributions are taxed during the year you earn and contribute that income, they typically don't need to be reported on your taxes, though you do need to abide by contribution limits.

Now that you have a clearer understanding of how 401(k) contributions impact your taxes, it's important to consider how you can maximize the benefits of your retirement savings. Whether you're contributing to a traditional 401(k) or considering a Roth 401(k), a sound retirement strategy can help you build wealth and ensure a bright financial future.

A Thrivent financial advisor can help you navigate various tax-advantaged savings vehicles, fine-tune your contribution strategy, and empower you with tax-efficient financial advice.