Author Topic: 401k contributions lower taxes?  (Read 641 times)

flowerofsun

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401k contributions lower taxes?
« on: November 23, 2018, 01:40:51 AM »
Hi guys,
I have been maxing out my 401K to lower my taxable income (I make 115K per year and, I believe I am  in 30% tax bracket)
I have been putting 18K every year...
Can you please help me to calculate how much my taxes will increase by if I do not contribute?

So here are few scenarios:

1) I continue to contribute 18K then:
 115K -18K (which is my 401K contribution) =lets say 100K for simplicity is my taxable income=taxes will be 30K, right?

2) I put only 4% (to get employer's match) then:
115K-4K (which is my 401K contribution)= 111K is my taxable income= taxes will be 33K per year, right?

3) I do not contribute anything at all (I don't think I will go for this choice but I am just using it for better understanding)
115K is my taxable income, then my taxes will be around 34.5K, right?


Thank you so much in advance!

wenchsenior

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Re: 401k contributions lower taxes?
« Reply #1 on: November 23, 2018, 06:55:41 AM »
Assuming you are in the U.S., it sounds like you might be a little confused about how taxes work.

If you are referring to federal taxes, there is no '30%' bracket.   As a single filer (and assuming the 115K is your net income after taking out payroll taxes and any deductible health insurance), then your marginal bracket is 24%.  Also, you are forgetting the standard deduction of 12K.

Your taxable income is taxed in each bracket (10%, 12%, 22% 24%, etc) as you 'fill up' that bracket with income, and therefore contributing to your 401 reduces the amount of your income that is available to fill up the higher bracket(s).

Roughly, it looks like your taxable income without 401K contribution would be:

115K -12K (SD)  = 103K taxable

(20,499 x .24) + (43,799 x .22) + (29,174 x .12) + (9,525 x .10) = ~4920 + 9636 + 3501 + 926 = 18,983 taxes owed
 


And with 401k contribution:
 
115K -12K (SD) 18K (401K) = 85K taxable

(2,499 x .24) + (43,799 x .22) + (29,174 x .12) + (9,525 x .10) =  ~600 + 9636 + 3501 + 926 = 14,633 taxes owed


You reduce taxes by ~$4,320 by maxing your 401k and reducing the amount of income in the 24% bracket.  Taxable income in the lower brackets remains the same.



2Birds1Stone

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Re: 401k contributions lower taxes?
« Reply #2 on: November 23, 2018, 07:07:10 AM »
Most importantly, why wouldn't you contribute to your 401k with that high of an income?!?!

terran

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Re: 401k contributions lower taxes?
« Reply #3 on: November 23, 2018, 07:13:25 AM »
First of all, with 115k gross income and no payroll other deductions (such as health insurance) you'll pay 7.65% x $100k = $8,797.50 in social security and medicare tax. This won't be changed by whether or not you contribute to a 401(k)

1) $115k gross income - $18k 401(k) = $92k Form W2, box 1
$97,000 W2 income
-$12,000 standard deduction for a single filer
= $85,000 taxable income

(85000 - 82500)24% + (82500 - 38700)x22% + (38700 - 9525)x12% + 9525x10% = $14,689.50 income tax

2) $115k gross income - $4k 401(k) = $111k Form W2, box 1
$111,000 W2 income
-$12,000 standard deduction for a single filer
= $99,000 taxable income

(99000 - 82500)24% + (82500 - 38700)x22% + (38700 - 9525)x12% + 9525x10% = $18,049.50 income tax
 


3) $1115k Form W2, box 1
$115,000 W2 income
-$12,000 standard deduction for a single filer
= $103,000 taxable income

(103000 - 82500)24% + (82500 - 38700)x22% + (38700 - 9525)x12% + 9525x10% = $19,009.50 income tax

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So in both cases 2 and 3 all of your forgone 401(k) contribution is being taxed at 24%. If you expect to need anything less than $82500 in retirement (probably even more depending on your mix of tax deferred vs taxable and Roth) you're better off contributing to the 401(k). If you'll need less than $38700 (or have much more in  taxable or Roth) then it makes even more sense to contribute.

If you're married now or in the future these calculations would change.

State taxes are also a factor if you live in a state that taxes income.

flowerofsun

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Re: 401k contributions lower taxes?
« Reply #4 on: November 27, 2018, 11:21:16 PM »
Wow! I did not expect such in depth replies! You guys are really smart! You really amazed me with your answers!
Thank you so much!
Your knowledge is very impressive!