Your employer deducts your contributions to your retirement plan from your paychecks, and forwards the payments to the plan provider. But if your employer doesn’t do the calculation properly, it may affect your take-home pay and the funding of your retirement account. Retirement deductions depend on whether your contributions are pretax or after-tax. If they’re pretax, only some of your wages might be subject to taxation when you make your contributions. If they’re after-tax, all of your wages are taxed.
Determine gross earnings for the pay period; this is your entire compensation before deductions. For example, let's say you earn $1,200 biweekly.
Calculate your retirement deduction from gross pay. Assume that you elect 5 percent toward your 401(k) plan. Multiply $1,200 by .05, which comes to $60.
Deduct retirement deduction from gross pay before calculating federal income tax if the plan is pretax. For example, subtract $60 from $1,200 to get $1,140. To determine federal income tax, apply the filing status and allowances you put on your W-4 form and Internal Revenue Service Circular E tax tables. (As an example, assume you claim married and two allowances on your W-4 form. Page 44 of the 2012 Circular E says you would pay $55 in federal income tax.)
Subtract applicable state and local income taxes based on the revenue agency’s rules. Most state and local governments follow federal procedures. If so, your wages of $1,140 would be subject to state and local taxes. If not, your entire wages of $1,200 would be taxed.
Figure Social Security tax at 4.2 percent of taxable wages up to $110,100 for the year, and Medicare tax at 1.45 percent of all taxable wages, as of 2012. Pretax retirement plans are subject to these two taxes, so your entire pay of $1,200 would be taxed.
Calculate taxes on your entire gross pay if the retirement plan is after-tax. For example, $60 would go toward your after-tax retirement account, and your entire earnings of $1,200 would be subject to all taxes.
- To arrive at your take-home pay, subtract any other after-tax deductions that you might have after calculating taxes.
- Pretax retirement plans include traditional 401(k), 403(b), 457(b) and individual retirement accounts. After-tax plans include Roth IRAs or 401(k)s.
- Pretax contributions give you tax savings on federal -- and in most cases state and local -- income taxes, but not on Medicare and Social Security taxes; income taxes are due when you withdraw your money from the plan. After-tax contributions don’t give tax savings during your work years; however, you don’t owe taxes on your contributions when you withdraw from the plan.
Grace Ferguson has been writing professionally since 2009. With 10 years of experience in employee benefits and payroll administration, Ferguson has written extensively on topics relating to employment and finance. A research writer as well, she has been published in The Sage Encyclopedia and Mission Bell Media.