A 401(k) offers tax-deferred growth, which means that earnings through interest accumulated on contributions to the 401(k) are not taxed until you make a withdrawal. The pre-tax contributions that you make to your 401(k) may not be deducted from your taxable income for the simple reason that the income they represent is not part of that included on your Form W-2 in the first place.
Deduction on W-2
When reporting your income on the line titled "Wages, salaries, and tips" on your federal income tax return, you use the amount in Box 1 — "Wages, tips, other compensation" — of your Form W-2, which your employer must provide to you. When your employer completes the form, it does not include in Box 1 the money you contributed to your 401(k).
Your employer may also make contributions for you to your 401(k) during the year. Those contributions also are not included in "Wages, tips, other compensation" on your Form W-2. Because neither your employer's contributions nor your pre-tax contributions are reported as income, you may not deduct them from your income.
Tax Savings of Contributions
The tax savings you reap from your 401(k) contributions and those made by your employer for the year depend on your income tax bracket. If the money were included in your taxable income, it would be taxed at your marginal tax rate — the rate at which your last dollar is taxed. For example, if you and your employer combine to contribute $12,000 and you pay a 37 percent tax rate, you save $4,440 on your taxes.
Retirement Savings Credit
Your contributions — but not those of your employer — to your 401(k) can help qualify you for the retirement savings credit. Your adjusted gross income must fall below the yearly caps and you may not be a full-time student for five or more months during the year. Depending on your income, the credit ranges from 10 percent to 50 percent of the amount you contributed, up to $2,000 of contributions. Therefore, the maximum benefit you may receive is $1,000.
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