401(k) Tax Benefit

How It Works

A traditional 401(k) offers one of the most powerful tax benefits available to employees. Contributions are made with pre-tax dollars, reducing your current taxable income dollar-for-dollar. The 2025 contribution limit is $23,500, with an additional $7,500 catch-up contribution for employees age 50 and older. A worker in the 24% bracket who contributes the maximum saves $5,640 in federal income tax that year. Many employers match contributions — a common formula is 50% of contributions up to 6% of salary — which is essentially free money. Employer matches don't count toward the employee contribution limit but do count toward the combined employee/employer limit of $70,000 for 2025. The tax benefit works in two directions: contributions reduce current-year taxes, and investment growth is tax-deferred. A $23,500 annual contribution growing at 7% for 30 years would accumulate to about $2.2 million — all without paying annual taxes on dividends or capital gains. Taxes are due only when you withdraw funds in retirement, ideally when you're in a lower tax bracket. However, the Roth 401(k) option flips this — you contribute after-tax dollars but withdrawals in retirement are tax-free. The choice between traditional and Roth depends on whether you expect your tax rate to be higher or lower in retirement. Required minimum distributions begin at age 73 for traditional 401(k) accounts, forcing taxable withdrawals whether you need the money or not. Roth 401(k) accounts are now exempt from RMDs starting in 2024, making them attractive for estate planning.