How 401(k) Contributions Lower Your Taxes

A traditional 401(k) is one of the most powerful tax-reduction tools available to working Americans, and it's sitting right there in your employee benefits package. Every dollar you contribute to a pre-tax 401(k) directly reduces the income the IRS taxes you on. It's not a deduction you have to itemize or calculate. It happens automatically on your paycheck, lowering your taxable income before you even see the money.

Let's walk through exactly how this works, see the math in action, and figure out how much you could actually save.

The Basic Mechanism: Pre-Tax Contributions

When you contribute to a traditional (pre-tax) 401(k), those dollars are subtracted from your gross income before federal and state income taxes are calculated. You still pay FICA taxes (Social Security and Medicare) on the full amount, but you skip income tax on everything you contribute. That money goes straight into your retirement account and grows tax-deferred until you withdraw it in retirement.

Here's the key insight: your tax savings are directly tied to your marginal tax bracket. If you're in the 22% federal bracket, every $1,000 you contribute saves you $220 in federal income tax. If you're in the 24% bracket, that same $1,000 saves you $240. The higher your bracket, the more valuable each pre-tax dollar becomes.

The Math: $80,000 Salary With 10% Contributions

Let's walk through a real example. Say you earn $80,000 per year as a single filer and decide to contribute 10% of your salary to your traditional 401(k). That's $8,000 per year, or about $667 per month.

Without 401(k) Contributions

• Gross income: $80,000
• Standard deduction: $15,000
• Taxable income: $65,000

Federal tax on $65,000 (single filer, 2025 brackets):

• 10% on first $11,925 = $1,192.50
• 12% on $11,926 to $48,475 = $4,386.00
• 22% on $48,476 to $65,000 = $3,635.50

Total federal tax: $9,214

With $8,000 in 401(k) Contributions

• Gross income: $80,000
• 401(k) contribution: $8,000
• Adjusted gross income: $72,000
• Standard deduction: $15,000
• Taxable income: $57,000

Federal tax on $57,000:

• 10% on first $11,925 = $1,192.50
• 12% on $11,926 to $48,475 = $4,386.00
• 22% on $48,476 to $57,000 = $1,875.50

Total federal tax: $7,454

The Savings

By contributing $8,000 to your 401(k), your federal tax bill dropped from $9,214 to $7,454. That's a savings of $1,760 in federal income tax alone. If you live in a state with income tax (say 5%), you'd save an additional $400, bringing your total tax savings to about $2,160.

Here's another way to think about it: you put $8,000 into your retirement account, but your take-home pay only decreased by about $5,840 ($8,000 minus $2,160 in tax savings). That means for every dollar that goes into your 401(k), it only "costs" you about 73 cents in reduced take-home pay. The government is essentially subsidizing your retirement savings.

See Your Own Tax Impact

Use the tax calculator below to compare your tax bill at different income levels. Try entering your salary with and without 401(k) contributions to see the exact difference.

2025 Contribution Limits

For 2025, the IRS has set the following 401(k) contribution limits:

• Under age 50: $23,500 maximum employee contribution
• Age 50-59 or 64+: $23,500 plus a $7,500 catch-up contribution, for a total of $31,000
• Age 60-63: $23,500 plus an enhanced catch-up of $11,250, for a total of $34,750 (this is a new provision starting in 2025)

These limits apply to employee contributions only. When you add employer matching and profit sharing, the total that can go into your 401(k) from all sources is $70,000 for 2025 (or $77,500 with catch-up contributions).

If you can max out your 401(k) at $23,500, and you're in the 22% bracket, that's a federal tax savings of $5,170. Add state taxes and it could easily be $6,000 or more. That's real money back in your pocket, or rather, money that was never taken out in the first place.

Plan Your Retirement Savings

Use the retirement calculator below to see how your 401(k) contributions can grow over time with compound interest and potential employer matching.

The Employer Match: Free Money With Tax Benefits

If your employer offers a 401(k) match, the tax benefits stack even further. A common match is 50% of the first 6% you contribute. On an $80,000 salary, contributing 6% ($4,800) gets you a $2,400 employer match. That's $2,400 of completely free money that also grows tax-deferred.

The match doesn't count against your $23,500 employee contribution limit. And it doesn't cost you a cent in taxes until you withdraw it in retirement. Not contributing enough to get the full match is literally leaving free money on the table. If you take away only one thing from this article, let it be this: always contribute at least enough to get your full employer match.

Traditional vs. Roth 401(k) Tax Treatment

Many employers now offer both traditional and Roth 401(k) options. The tax treatment is completely different:

• Traditional 401(k): Contributions are pre-tax, reducing your taxable income now. You pay ordinary income tax on withdrawals in retirement. This is the approach that gives you an immediate tax break.
• Roth 401(k): Contributions are after-tax, so you don't get a tax deduction now. But qualified withdrawals in retirement are completely tax-free, including all the growth.

Which is better? It depends on whether you think your tax rate will be higher now or in retirement. If you're in a high bracket today and expect to be in a lower one in retirement, traditional is usually better because you're deferring taxes from a high rate to a low rate. If you're early in your career and in a low bracket, Roth can be attractive because you're paying tax at a low rate now and getting tax-free growth for decades.

The Ripple Effects of Lower Taxable Income

Reducing your taxable income through 401(k) contributions can trigger additional benefits beyond the direct tax savings:

• Student loan repayment: Income-driven repayment plans use your adjusted gross income (AGI). Lower AGI means lower monthly student loan payments.
• Health insurance subsidies: If you buy insurance through the marketplace, premium subsidies are based on your modified AGI. Lower income could qualify you for larger subsidies.
• Child tax credit and other credits: Some tax credits phase out at higher incomes. Reducing your AGI might keep you within the eligibility window.
• Roth IRA eligibility: Your ability to contribute directly to a Roth IRA phases out at certain income levels. 401(k) contributions lower your AGI, which could keep you below the phase-out threshold.

When You'll Pay the Tax

Traditional 401(k) contributions aren't tax-free. They're tax-deferred. You'll pay ordinary income tax on every dollar you withdraw in retirement. The bet you're making is that your tax rate in retirement will be lower than your tax rate today. For most people, that's a reasonable assumption since retirement income typically comes from a combination of Social Security, 401(k) withdrawals, and perhaps a pension, often totaling less than peak working income.

There are also required minimum distributions (RMDs) starting at age 73 (as of current rules). The IRS will eventually make you take money out and pay tax on it. That's the trade-off for decades of tax-deferred growth.

The Bottom Line

Contributing to a traditional 401(k) is one of the simplest and most effective ways to lower your tax bill while simultaneously building retirement savings. The math is straightforward: every dollar you contribute reduces your taxable income by a dollar, saving you money at your marginal tax rate. On an $80,000 salary with a 10% contribution rate, that's over $1,700 in annual federal tax savings. Factor in state taxes, employer matching, and decades of tax-deferred compound growth, and the 401(k) is arguably the best financial tool most Americans have access to. Start with enough to get your employer match, then increase your contribution rate by 1% each year until you're maxing it out. Future you will be grateful.