November 27, 2014
How are your federal and state income taxes affected when you invest in a traditional retirement plan like a 401(k) or a 403(b)?
How are your federal and state income taxes affected when you invest in a traditional retirement plan like a 401(k) or a 403(b)?
When you invest in a traditional 401k it is like you did not make that money for that time period. The money is take out before taxes are applied and lower your taxable earnings. You will have to pay taxes on that money and the earnings of it when it comes time that you take the money out. You can improve your tax situation in a year by putting money in your 401k, you will just have to pay those taxes latter.
Well said, Garrett. Let’s review.
Let’s say you earn $60,000 a year and put away $10,000 in your traditional (pre-tax) 401(k) at work, you have now reduced your taxable income (federal and state) to $50,000 ($60,000 – $10,000). This may not eliminate those taxes, but it does defer them until a later date AND it places your money in a tax sheltered vehicle that will also defer the taxes on your earnings until a later date. Winner, winner, chicken dinner!