Does Increasing Your 401k Decrease Your Federal Taxes?

A 401(k) plan is a retirement savings vehicle in the United States, allowing you to invest directly from your paycheck. Beyond its function as a retirement account, a 401(k) can also alter your annual federal tax obligations. The type of contributions you make determines the nature and timing of these tax implications, making it a tool for both long-term saving and current-year tax strategy.

How Pre-Tax 401(k) Contributions Reduce Taxable Income

When you contribute to a traditional, pre-tax 401(k) plan, you are lowering your taxable income for the year. These contributions, often called elective deferrals, are taken from your gross pay before your employer calculates the federal income tax to be withheld. This direct reduction of your reportable income means the final amount of tax you owe is lowered. For example, if you earn a salary of $60,000 and contribute $6,000 to a traditional 401(k), your taxable income is reduced to $54,000.

This tax advantage applies to federal and typically state income taxes. However, these contributions do not reduce the amount of wages subject to Social Security and Medicare taxes, collectively known as FICA taxes. This deferred tax treatment means you receive a tax break now, but the funds and all investment gains will be taxed as ordinary income upon withdrawal in retirement. Your reduced taxable income is reflected on your annual Form W-2.

Comparing Traditional vs. Roth 401(k) Tax Treatment

The tax implications of your 401(k) contributions depend on whether you use a Traditional or a Roth account. The Traditional 401(k) provides an immediate tax benefit, as contributions are made on a pre-tax basis, which lowers your adjusted gross income (AGI) for the year. The investments within the account grow tax-deferred, and withdrawals during retirement are taxed as ordinary income.

In contrast, a Roth 401(k) operates with the opposite tax structure. Contributions are made with after-tax dollars, meaning you receive no upfront tax deduction. The advantage of the Roth option emerges in retirement. As long as you are at least 59 ½ years old and have held the account for five years, all qualified withdrawals, including both contributions and their earnings, are tax-free.

Choosing between these accounts is a strategic decision about when you would rather pay taxes. If you anticipate being in a higher tax bracket during your working years than in retirement, the Traditional 401(k) may be more advantageous. Conversely, if you expect to be in a similar or higher tax bracket in retirement, the Roth 401(k) could be the better choice.

Calculating Your Potential Federal Tax Savings

To illustrate the financial impact, consider an individual with an annual salary of $70,000 who contributes 6% of their pay to a traditional 401(k). This results in an annual contribution of $4,200. By making this pre-tax contribution, the employee’s taxable income is reduced from $70,000 to $65,800.

The tax savings are calculated based on the employee’s marginal tax rate—the rate applied to their highest dollars of income. Assuming this individual falls into the 22% federal tax bracket, the direct tax savings for the year are calculated by multiplying the contribution amount by this rate.

In this scenario, the calculation is $4,200 multiplied by 22%, which equals $924. This figure represents the federal income tax the individual avoided paying for that year, with taxation on the funds postponed until retirement.

Contribution Limits and Other Factors

The Internal Revenue Service (IRS) sets annual limits on how much an employee can contribute to their 401(k). For 2025, the maximum elective deferral limit is $23,500. This limit applies to the total amount you contribute across both Traditional and Roth 401(k) plans and is a personal limit per individual, not per plan.

Workers age 50 and over are permitted to make additional “catch-up” contributions. For 2025, this additional amount is $7,500, allowing eligible individuals to contribute a total of $31,000. A new provision for 2025 allows for an even higher catch-up contribution for those aged 60, 61, 62, and 63. If their plan adopts this option, individuals in this age group can contribute an additional $11,250, for a maximum total of $34,750.

Many employers offer a matching contribution as an incentive for employees to save. For instance, an employer might match 50% of employee contributions up to 6% of their salary. These employer funds do not affect your personal taxable income for the year and do not count toward your annual elective deferral limit.