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What do you mean by "tax-deferred",
and how do tax-deferred contributions benefit me?
"Tax-deferred
contributions" with a 401(k) plan means that no federal or state
income tax is immediately payable on the amount of pay you choose to
defer. You pay no federal or state income tax on your deferrals
until you withdraw the money from your plan. Similarly, no current
income tax is due on any employer matching contributions. Here's an
example:
Assume you earn
$21,500 a year and want to save 5% of your pay, or $1,075. You file
a joint return and you and your spouse are in the 28% federal tax
bracket. Here is a comparison showing how contributing through a
tax-deferred 401(k) plan, rather than an after-tax savings plan, can
result in an increase in your net take home pay.
Retirement
Savings
| |
Without 401(k) |
With 401(k) |
|
Gross Pay |
$21,500
|
$21,500
|
|
401(k) Deferral |
0
|
-1,075
|
|
Taxable Pay |
$21,500
|
$20,425
|
|
Federal Income Tax |
-6,020
|
-5,719
|
|
FICA (7.65%) |
-1,645
|
-1,645
|
|
State Income Tax (assumes 6%) |
-1,290 |
-1,225 |
|
Savings (after-tax savings program) |
-1,075
|
0
|
|
Net Take Home Pay |
$11,470
|
$11,836
|
In addition, any
earnings on your 401(k) deferrals (or employer contributions, if
any) also avoid federal and state income tax until they are
distributed from the plan. Deferring taxes can make a big
difference in how much money you will have at retirement.
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