Hey everyone, I’m Bette Hochberger, CPA, CGMA. Saving for retirement is one of the smartest financial moves you can make, but did you know it can also help reduce your taxable income today? If you’re wondering whether contributing to a 401(k) plan can lower the amount of income you’re taxed on, the short answer is yes, it absolutely can.For today’s quickie, I’ll go over how it works and why taking advantage of a 401(k) is a win-win for your retirement and your taxes.

What Is a 401(k), Anyway?

A 401(k) is a retirement savings plan offered by employers that lets you set aside a portion of your paycheck for retirement. The money you contribute goes into an investment account, where it can grow over time. There are two main types of 401(k) accounts: traditional and Roth. Each has its own tax benefits, but for this blog, we’ll focus on the traditional 401(k), which is the one that helps reduce your taxable income.

How a 401(k) Reduces Your Taxable Income

Contributions to a traditional 401(k) are made with pre-tax dollars. This means the money is taken out of your paycheck before taxes are calculated. By lowering your taxable income, you end up paying less in federal income taxes today. Here’s an example:

  • Let’s say you earn $60,000 per year and you contribute $6,000 to your 401(k).
  • Your taxable income is reduced to $54,000 ($60,000 – $6,000).
  • Since your taxes are based on the $54,000, not the full $60,000, you’ll owe less in taxes.

This tax benefit applies to federal income tax, and in many cases, state income tax too (depending on where you live). Plus, the more you contribute (up to the annual limit), the more you can potentially save on taxes.

How Much Can You Contribute?

For 2025, the IRS allows you to contribute up to $23,500 annually to your 401(k) if you’re under age 50. If you’re 50 or older, you can contribute an additional $7,500 in catch-up contributions, bringing your total to $31,000. The more you contribute, the greater the reduction in your taxable income—up to these limits.

What About the Taxes Later?

While a traditional 401(k) provides tax savings now, you will have to pay taxes later when you start withdrawing the money in retirement. These withdrawals are taxed as ordinary income. However, many people find themselves in a lower tax bracket after retirement, which means they pay less in taxes overall.

Roth 401(k): A Quick Note

On the flip side, contributions to a Roth 401(k) are made with after-tax dollars, meaning they don’t reduce your taxable income today. However, the big benefit is that your withdrawals—including earnings—are tax-free in retirement. Depending on your financial situation, you might even choose to contribute to both a traditional and a Roth 401(k).

Why It’s a Smart Move

Contributing to a 401(k) doesn’t just reduce your taxable income—it also helps you build a secure retirement. By automating your savings and taking advantage of employer match programs (if available), you can grow your retirement nest egg while enjoying the immediate tax benefits.

So, to sum it up- yes, contributing to a traditional 401(k) is a powerful way to lower your taxable income while saving for your future. The tax savings you enjoy today can free up room in your budget for other financial goals, like paying off debt or building an emergency fund. So, if you’re not already taking advantage of your 401(k), now’s the perfect time to start—you’ll thank yourself later!

I’ll see you all next time!