Does 401(k) Contribution Count as Earned Income?
Understand how 401(k) contributions impact earned income classification, tax withholding, and reporting requirements for employees and the self-employed.
A 401(k) is a retirement savings plan that allows employees to set aside a portion of their earnings for the future. Contributions can be pre-tax or Roth (after-tax), depending on the plan. Since these contributions often reduce taxable income, it’s important to understand whether they still count as earned income for tax and benefit purposes.
Distinguishing 401(k) Contributions From Earned Income
Earned income includes wages, salaries, tips, and other compensation for work performed. When an employee contributes to a 401(k), the money is deducted from their paycheck before they receive it, but the IRS still considers the full pre-contribution salary as earned income.
For example, contributions to a traditional or Roth IRA require earned income. Since 401(k) deferrals come from wages, they count toward this requirement. Even if an employee directs a large portion of their paycheck into a 401(k), their total salary before deductions still qualifies as earned income for IRA contributions.
For Social Security, 401(k) contributions do not reduce the earnings subject to payroll taxes. Social Security and Medicare taxes are calculated based on gross wages before any 401(k) deferrals. This ensures that contributing to a 401(k) does not lower future Social Security benefits, which are based on lifetime earnings reported to the Social Security Administration.
Tax Withholding and 401(k) Deferrals
When employees contribute to a traditional 401(k) on a pre-tax basis, their taxable income is reduced for federal and most state income tax purposes. However, this does not eliminate tax withholding. Employers calculate federal income tax withholding based on adjusted gross pay after 401(k) deferrals, which lowers immediate tax liability.
Payroll taxes—Social Security and Medicare—still apply to gross earnings before 401(k) deductions. Employees pay 6.2% Social Security tax on earnings up to the annual wage base limit ($168,600 in 2024) and 1.45% Medicare tax on all wages. An additional 0.9% Medicare surtax applies to earnings above $200,000 for single filers or $250,000 for married couples filing jointly.
State tax treatment varies. Most states follow federal rules and exclude pre-tax contributions from taxable income, but some, such as Pennsylvania and New Jersey, tax 401(k) contributions at the state level.
EITC and 401(k) Contributions
The Earned Income Tax Credit (EITC) is a refundable credit for low-to-moderate-income workers. Eligibility depends on income level, filing status, and the number of qualifying children.
For EITC calculations, earned income includes wages and salaries before 401(k) deferrals. This means contributing to a 401(k) does not reduce earned income for EITC purposes. However, because taxable income is lowered by pre-tax 401(k) contributions, an employee may end up in a lower tax bracket, which can influence their overall tax refund.
The credit decreases as income rises beyond a certain level, meaning a higher salary can reduce or eliminate eligibility. Since 401(k) contributions do not lower earned income for EITC qualification, employees cannot use deferrals to stay below these limits. For example, in 2024, the maximum earned income to qualify for the EITC for a single filer with one child is $46,560. An employee earning $48,000 who defers $3,000 into a 401(k) would still be above the threshold and ineligible for the credit.
Employer Contributions vs. Employee Deferrals
Employer contributions to a 401(k) differ from employee deferrals in structure and tax treatment. Employers may match a percentage of an employee’s salary or make non-elective contributions, but these amounts are not deducted from the employee’s paycheck and do not affect taxable wages in the year they are deposited.
Employee deferrals are capped at $23,000 for 2024 ($30,500 for those 50 and older with catch-up contributions). Total contributions—including both employee and employer amounts—must stay within the IRS annual limit of $69,000 ($76,500 with catch-up contributions). Employers must also comply with nondiscrimination testing, such as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, which prevent highly compensated employees from benefiting disproportionately. Failing these tests can result in excess contributions being refunded, creating unexpected tax liabilities.
Self-Employed 401(k) Considerations
Self-employed individuals can contribute to a Solo 401(k), which allows for both employee deferrals and employer contributions. This structure provides flexibility in retirement savings but requires careful tax planning.
Employee deferrals follow the same limits as traditional 401(k) plans—$23,000 in 2024, or $30,500 with catch-up contributions for those 50 and older. Employer contributions are limited to 25% of compensation for incorporated businesses or 20% of net self-employment income after deducting self-employment taxes. For example, a sole proprietor earning $100,000 in net income could contribute up to $20,000 as an employer contribution, in addition to the employee deferral, provided total contributions do not exceed the $69,000 annual limit.
Self-employed individuals must report contributions correctly. Employee deferrals are deducted on Schedule 1 of Form 1040, while employer contributions are recorded as an adjustment to income. If plan assets exceed $250,000, the IRS requires filing Form 5500-EZ annually. Unlike traditional employees, self-employed individuals must manage their own recordkeeping and ensure contributions are made before the tax filing deadline, including extensions, to maximize tax benefits.
Reporting Requirements
Properly reporting 401(k) contributions ensures compliance with IRS regulations. While contributions are deducted directly from payroll for employees, they must be accurately reflected on tax documents.
For employees, pre-tax 401(k) deferrals are reported in Box 12 of Form W-2 with code “D.” These contributions do not appear in Box 1 as taxable wages but are included in Social Security and Medicare wages (Boxes 3 and 5). Roth 401(k) contributions, however, are reported in the same box but remain part of taxable wages. Employees should verify their W-2 to ensure accurate reporting.
Self-employed individuals report contributions differently. Employee deferrals are deducted on Schedule 1 of Form 1040, while employer contributions are recorded as an adjustment to income. S corporation owners must reflect contributions in corporate tax filings, with employee deferrals deducted from W-2 wages. Accurate reporting prevents tax complications and ensures compliance with IRS limits.