The relationship between your W-2 and your 401(k)

Let ‘s talk about how a 401 ( thousand ) impacts your W-2. You receive a W-2 from your employer after the close of the tax year showing your taxable earnings in Box 1. When you do your taxes, you use box 1 to fill in line 7 ( wages ) of your tax return. Your tax bill is figured on that number. When you make a pre-tax 401 ( thousand ) contribution, that sum does not show up in Box 1. Your employer ‘s contribution, whether it be a match or early contribution, besides is not included in Box 1 .
Let me give you examples of an employee who does not participate in his caller ‘s 401 ( potassium ), and two who do. In each shell, the employee earns $ 1,000 a week, or $ 52,000 a class, and is single.

employee A is not participating in a 401 ( k ). His W-2 Box 1 shows $ 52,000 of taxable wages. As a one file clerk, his federal income-tax bill will be approximately $ 6,435 .
employee B is contributing 5 percentage of his wage to the pre-tax 401 ( thousand ) ( $ 2,600 for the year ). His Box 1 shows taxable wages of $ 49,400, even though he earned $ 52,000. Employee B ‘s union income-tax bill will be approximately $ 5,785, or $ 650 less than Employee A ‘s .
From the IRS ‘s steer of view, Employee B earned $ 2,600 less than he truly did. That ‘s one tax advantage of your pre-tax 401 ( k ). The other is tax-deferral that lasts until you start to withdraw money from your 401 ( thousand ) .

Employee C is contributing the lapp sum as Employee B, but his design provides for a dollar-for-dollar equal. His Box 1 will show taxable income of $ 49,400 as does Employee B ‘s. But he earned an extra $ 2,600 due to the pit. Keeping in heed that his couple has to vest in accord with his 401 ( kelvin ) plan ‘s provisions, Employee C ‘s “ income ” is $ 54,600, but he is taxed on entirely $ 49,400 .
If he were to pay taxes on the full $ 54,600, his federal tax bill would be about $ 7,085. rather, his tax bill is only $ 5,785, which you can think of as “ savings ” of $ 1,300 .
again, that ‘s identical to Employee B ‘s tax bill, even though Employee C earned $ 2,600 more due to the match. An authoritative thing to remember about coordinated is this : If Employee C leaves the company before vest, he wo n’t be able to take the catch with him .
Let ‘s look at these three examples from a cost/benefit steer of watch.

employee A, who does not participate in his design, has no tax benefit and no savings .
employee B saved $ 2,600 of his own money through payroll contributions. In accession, he got a open frame from Uncle Sam, saving $ 650 that he would have had to pay in taxes, but does n’t .
employee B is ahead of Employee A by $ 650, plus Employee B has $ 2,600 saved for retirement, whereas Employee A has zero savings .
Employee C saved $ 5,200, which was $ 2,600 of his own money through payroll contributions, plus the employee couple. In summation, he saved $ 650 in taxes, just like Employee B .
Employee C is ahead of Employee A by $ 650 in tax savings. Plus he has $ 5,200 saved for retirement .
You can look at these examples another room. You can ask yourself about what it actually “ cost ” each employee to save money for retirement, after accounting for tax savings .
Employee B ‘s cost was $ 2,600 minus $ 650 in tax savings, or $ 1,950. You can think of this as buying a $ 2,600 investment for merely $ 1,950, a deduction of 25 percentage .
Employee C ‘s cost was the same as Employee B ‘s ( $ 1,950 ) but his 401 ( k ) balance was twice american samoa high ( $ 5,200 versus $ 2,600 ). Employee C paid only $ 1,950 for his $ 5,200 investment, a deep deduction of 62.5 percentage.

While you ‘ll have to pay taxes on withdrawals you take from your pre-tax 401 ( kilobyte ) after you retire, there is no way to beat the baron of the 401 ( k ) as a savings vehicle, specially if your employer contributes to the design .
Julie Jason welcomes your questions and comments at

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