How 401(k) Contributions Affect Your Paycheck and Taxes

Traditional contributions save tax at your current marginal rate; Roth contributions save tax at your future rate. If you expect to be in a lower bracket in retirement, traditional usually wins; if you are early in your career and in a low bracket, Roth is often attractive. Many people split contributions between both.

Because traditional contributions are excluded from federal (and usually state) taxable wages, your net pay falls by less than the amount you save. Illustration for an employee in the 22% federal bracket and a 5% state tax, contributing $200 per paycheck:

FICA is unchanged, because Social Security and Medicare apply to 401(k) deferrals. Model your own numbers with the paycheck calculator. On your pay stub, the difference shows up as Box 1 wages on your W-2 being lower than Social Security wages in Box 3 — a detail covered in our pay stub guide.

Many employers match part of what you contribute, for example 50% of contributions up to 6% of pay. That is an immediate, guaranteed return on your money before any investment growth. Contributing at least enough to receive the full match is the single highest-value step for most employees. Check your plan's vesting schedule too: matched dollars may require a few years of service before they are fully yours.

The IRS sets an annual employee deferral limit, adjusted for inflation, plus a higher catch-up amount for workers aged 50 and older (with an enhanced catch-up for certain ages under recent law). Employer contributions count toward a separate, larger combined limit. Current limits are published each fall by the IRS; our retirement calculator lets you project balances at different contribution rates.

• Start with at least the percentage that earns the full employer match.
• Keep an emergency fund outside the plan; early withdrawals usually face income tax plus a 10% penalty.
• Increase the rate by 1% each time you get a raise — you will barely notice the difference in net pay.
• If you are near a bracket threshold, traditional contributions can keep more income in the lower bracket.
• Revisit traditional vs. Roth when your income changes significantly.

Freelancers without an employer plan can open a solo 401(k) or SEP-IRA. Contributions reduce income tax but, as with employees, not self-employment tax. See the self-employment tax guide for how the two interact.