Does a 401(k) Reduce Adjusted Gross Income?

401(k) plans are a widely used vehicle for retirement savings, offering various tax advantages that can influence a taxpayer’s financial situation. Understanding how contributions to a 401(k) interact with Adjusted Gross Income (AGI) is important for effective tax planning. This article explores the relationship between 401(k) contributions and AGI, clarifying their tax impact.

Understanding Adjusted Gross Income

Adjusted Gross Income (AGI) is a fundamental figure in tax calculations, representing an individual’s gross income minus specific deductions. Gross income includes all sources of taxable income, such as wages, salaries, interest, dividends, and business income.

AGI is a starting point for determining various tax liabilities, eligibility for tax credits, and limitations on certain deductions. A lower AGI can potentially result in a reduced tax bill and increased eligibility for certain tax benefits.

Traditional 401(k) Contributions and AGI

Contributions to a Traditional 401(k) are typically made on a pre-tax basis. This pre-tax treatment directly reduces an individual’s taxable income in the year the contributions are made. For instance, if an employee earns $70,000 and contributes $10,000 to a Traditional 401(k), their taxable income for AGI calculation purposes would effectively be $60,000.

This dollar-for-dollar reduction in taxable income consequently lowers an individual’s Adjusted Gross Income. Taxes on both the contributions and any investment earnings are deferred until retirement, when withdrawals are typically subject to ordinary income tax. This deferral can be particularly advantageous if an individual anticipates being in a lower tax bracket during retirement.

Roth 401(k) Contributions and AGI

In contrast to Traditional 401(k)s, contributions made to a Roth 401(k) are funded with after-tax dollars. This means that income tax is paid on the earnings before they are contributed to the account. Because these contributions have already been taxed, they do not reduce an individual’s taxable income or their Adjusted Gross Income in the year they are made.

The tax benefit for Roth contributions occurs later, during retirement. Qualified withdrawals from a Roth 401(k), including both contributions and earnings, are entirely tax-free, provided certain conditions are met, such as the account being open for at least five years and the account holder being at least 59½ years old. This structure offers tax-free growth and tax-free withdrawals in retirement, but it does not provide an immediate AGI reduction.

Other Considerations for AGI Reduction

The Internal Revenue Service (IRS) sets annual contribution limits for 401(k) plans, which cap the amount by which AGI can be reduced through Traditional 401(k) contributions. For 2025, the employee elective deferral limit for 401(k) plans is $23,500. Individuals aged 50 and over are eligible to make additional “catch-up” contributions, which can further increase their AGI reduction. For 2025, the standard catch-up contribution is $7,500, with a higher amount of $11,250 for those aged 60 to 63, if their plan allows.

Employer contributions, such as matching contributions or profit-sharing contributions, also play a role in a 401(k) plan’s overall growth. However, these employer contributions do not directly reduce the employee’s Adjusted Gross Income. While they contribute to the total amount saved in the retirement account, they are not considered a deduction from the employee’s gross income for AGI calculation purposes. The combined limit for employee and employer contributions to a 401(k) in 2025 is $70,000, or $77,500 including the standard catch-up contribution for those 50 and over, and $81,250 for those aged 60-63.