401(k) contributions reduce your taxable income, which also reduces the amount of FICA taxes (Social Security and Medicare) you pay. FICA taxes are not withheld from 401(k) contributions, so you do not pay FICA taxes on the money that you contribute to your 401(k). However, you will pay FICA taxes on the money that you withdraw from your 401(k) in retirement.
Pre-tax and Post-tax Contributions
401(k) contributions can be made on a pre-tax or post-tax basis. Pre-tax contributions are made with before-tax dollars, which means that they reduce your taxable income. This can save you money on taxes today. However, when you withdraw money from your 401(k) in retirement, you will have to pay taxes on the entire amount, including the earnings.
Post-tax contributions are made with after-tax dollars, which means that they do not reduce your taxable income. This means that you will not save any money on taxes today. However, when you withdraw money from your 401(k) in retirement, you will only have to pay taxes on the earnings.
The table below summarizes the key differences between pre-tax and post-tax 401(k) contributions.
| Type of Contribution | Tax treatment of contributions | Tax treatment of withdrawals |
|---|---|---|
| Pre-tax | Reduce taxable income | Taxed as ordinary income |
| Post-tax | Do not reduce taxable income | Taxed only on earnings |
Employer and Employee Contributions
Contributions to a 401(k) plan can be made by both employers and employees. Employer contributions are made on a pre-tax basis, meaning that they are deducted from the employee’s paycheck before taxes are calculated. Employee contributions can be made on a pre-tax or post-tax basis. Pre-tax contributions are deducted from the employee’s paycheck before taxes are calculated, while post-tax contributions are deducted from the employee’s paycheck after taxes have been calculated.
Employer contributions to a 401(k) plan are not subject to FICA taxes. However, employee contributions to a 401(k) plan are subject to FICA taxes. This is because employee contributions are considered to be wages.
- Employee contributions to 401(k) plans are subject to FICA taxes.
- Employer contributions to 401(k) plans are not subject to FICA taxes.
| Contribution Type | FICA Taxable |
|---|---|
| Employer Contributions | No |
| Employee Contributions | Yes |
FICA Taxable Limit
The Federal Insurance Contributions Act (FICA) is a payroll tax that funds Social Security and Medicare. FICA taxes are withheld from your paycheck and matched by your employer. The FICA taxable limit is the maximum amount of your wages that are subject to Social Security and Medicare taxes. For 2023, the FICA taxable limit is $160,200 for Social Security and $147,900 for Medicare.
- Social Security tax rate: 6.2%
- Medicare tax rate: 1.45%
If you earn more than the FICA taxable limit, you will not pay any additional Social Security or Medicare taxes on your wages. However, you will still be subject to income tax on your entire income.
| Tax | Taxable Limit | Tax Rate |
|---|---|---|
| Social Security | $160,200 | 6.2% |
| Medicare | $147,900 | 1.45% |
Tax Implications in Retirement
Withdrawals from traditional 401(k) accounts are taxed as ordinary income. This means that you’ll pay taxes on the amount you withdraw, plus any earnings that have accumulated in the account.
The tax rate you pay will depend on your income and filing status. For example, if you’re in the 25% tax bracket, you’ll pay 25% of your withdrawal amount in taxes. If you’re in the 15% tax bracket, you’ll pay 15% of your withdrawal amount in taxes.
In addition to income taxes, you may also have to pay state and local taxes on your 401(k) withdrawals. The amount of state and local taxes you pay will depend on the laws in your state and locality.
If you withdraw money from your 401(k) before you reach age 59½, you’ll have to pay a 10% early withdrawal penalty. This penalty is in addition to any income taxes and state and local taxes that you may owe.
There are some exceptions to the 10% early withdrawal penalty. For example, you can withdraw money from your 401(k) without penalty if you’re disabled, if you’re taking the money to pay for qualified medical expenses, or if you’re receiving substantially equal periodic payments.
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