What Is a Pretax Contribution?

A pretax contribution defers taxes until withdrawal, which is typically durin𝔍g retirement.

For example, if you set aside $10,000 of your salary to contribute to a traditional 401(k) plan in 2024, you don’t have to pay 澳洲幸运5官方开奖结果体彩网:income taxes on that $10,000 of income in 2024. You will need to pay taxes on it when you withdraw funds (contributions, earnings, and any 澳洲幸运5官方开奖结果体彩网:employer match) during retirement, whether that’s 2034, 2044, or 2074.

This is in contrast to both after-tax contributions and Roth contributions. Several tax-advantaged accounts allow pretax contributions, including traditional (not Roth) 401(k)s and 澳⛎洲幸运5官方开奖结果体彩网:individual retirement accounts (IRAs), as well as 403(b) and 457 plans.

Pretax vs. After-tax Contributions

If a contribution is made with income for which an individual has already paid tax, it is referred to as an 澳洲幸运5官方开奖结果体彩网:after-tax contribution. This is different from pre🔯tax and Roth contributions. (See more about Roth contributions below.)

With an after-tax contribution, you deposit income into a traditional or Roth retirement account after paying taxes on it. Though there are no immediate tax breaks, the earnings on aft﷽er-tax contributions grow tax deferred until they are withdrawn.

Contributions to a traditional (non-Roth) retirement savings plan can be in the form of pretax and/or after-tax contributions. (However, Roth🅰 accounts also allow for after-tax contributions.) After-tax contributions can be made instead of or in addition to pretax contributions.

This type of contribution is popular with high earners who have maxed out their 401(k) by contributing up to the limit with pr🌠etax or Roth contributions.

For tax year 2024, according to the 澳洲幸运5官方开奖结果体彩网:Internal Revenue Service (IRS), if you’re younger than 50 years old, the most you can contribute to a 401(k) is $23,000. If you’re 50 or older, you can take advantage of an option to contribute an additional $7,500 in 澳洲幸运5官方开奖结果体彩网:catch-up contributions.

There is a limit on contributions from all sources, including employer contributions, every year. The tax year 2024 limit is $69,000 for people under 50, with an additional $7,500 for people ages 50 and older.

Pretax vs. Roth Accounts

With a Roth account, such as a Roth 401(k) or 澳洲幸运5官方开奖结果体彩网:Roth individu🀅al retirement account (IRA), you pay taxes upfront, in the year you make the contribution, so in retirement, you can withdraw the funds tax free, as long as you’ve had the account for five years (in the case of a Roth IRA) and yo𝓀u’re over age 59½.

If you are trying to decide whether to make 澳洲幸运5官方开奖结果体彩网:pretax or Roth contributions, one strategy is to compare your current tax bracket with your e꧃xpecte♓d tax bracket at retirement.

If you expect to be in a lower tax bracket at retirement, go the traditional route, and make pretax contributions. If you expect to be in a higher tax bracket at retirement, contribute to a Roth account instead. You’re aiming to withdraw funds when your income tax bracket is the lowest, to reduce the taxes you’ll need to pay.

However, you should also bear in mind that tax rules and brackets change over time. There’s no way to truly know what the future holds, so take your best guess.

Tax Savings Example

Pretax contributions lead to tax savings.

For example, consider a married employee who earns $105,000 in 澳洲幸运5官方开奖结果体彩网:gross income in tax year 2024. If their 澳洲幸运5官方开奖结果体彩网:effective tax rate is 20%, their tax liability for the year will be 0.20 × $105,000 = $21,000, leaving the employee with $84,000 ($105,000 - $21,000) in take-home pay.

However, if that under-50 employee maxes out their 401(k) plan with a $23,000 pretax contribution, their 澳洲幸运5官方开奖结果体彩网:taxable income will be reduced to $82,000 ($105,000 - $23,000), and their tax liability will be $16,400 (0.2 × $82,000), which is a savings of $4,600 ($21,000 - $16,4💧00).

In calculating a pretax contribution, as this example shows, the amount of taxes withheld will be reduced as the bas🥂is for the taxable amount will be reduced.

The Bottom Line

Pretax contributions enable you to earmark funds for a retirement plan using income that has not been subject to payroll or income taxes.

Pretax contributions reduce your amount of taxable income now, which lowers your tax bill now. These taxes are deferred. You pay income tax on your contributions and earnings when you withdraw money from𒊎 the account, which is typically during retirement.

If you have any questions about contributing to your retirement plan, talk to your 澳洲幸运5官方开奖结果体彩网:human resources department or your 澳洲幸运5官方开奖结果体彩网:plan administrator.