Using a 401(k) plan allows you to squirrel away money for retirement without having to pay taxes on it. Your money will grow tax-free until you take it out of the account. Contributions to traditional 401(k) plans reduce your adjusted gross income, but they typically are not reported on your income tax return.
You can report contributions to 401(k), but you can only deduct up to a certain amount on your taxes.
Contributions Excluded From Income
The reason you normally don’t take a deduction for 401(k) plan contributions is that they have already been excluded from your taxable income. When you make the contributions through payroll deductions, your employer reduces the amount of income reported on your Form W-2. For example, say your salary is $59,000 but you contribute $5,000 to your 401(k) plan. On your W-2, Box 1 -- "Wages, tips, other compensation" -- it will only show $54,000.
401(k) Plans for Self-Employed Individuals
If you’re self-employed or work as an independent contractor, you don’t get a W-2. However, you’re allowed to set up a 401(k) plan and make contributions for yourself. You record deductions on line 28 of Form 1040, and it reduces your adjusted gross income.
For example, say you’re a freelance writer who started your own 401(k) plan. If you make $56,000 but put $7,000 in your own 401(k) plan, you must report the full $56,000 as income, but you may deduct $7,000 when calculating your adjusted gross income.
Contributions for Your Employees
If you own a small business and you have employees, any 401(k) plan you set up for yourself often must also cover your employees. If you make contributions as the employer, you’re allowed to deduct the contributions on Schedule C as a business expense. This not only reduces your taxable income but also lowers your self-employment taxes for the year.
Roth 401(k) Contributions
Unlike traditional 401(k) contributions, Roth 401(k) plan contributions don’t reduce your adjusted gross income because they are made with after-tax dollars. For example, contributing $5,000 to an employer-sponsored Roth 401(k) plan won’t reduce your income on your W-2 and you cannot deduct it on your tax return. Instead, you receive the benefit of tax-free qualified distributions. Once your Roth 401(k) is at least 5 years old and you’re either 59 1/2 or permanently disabled, you can take all the money out without paying any taxes.
Evaluating Contribution Limits
Even though these benefits sound promising, you're limited as to how much you can claim as a contribution each year. In 2019, you can only contribute $19,000 as tax-deductible income. This limit does not include the amount your employer contributes to your 401(k).
- What Are My Retirement Plan Options If I Have No Plan Through My Employer?
- Do 401(k) Deductions Affect Social Security Withholdings?
- Can I Have a Self-Employed 401(k) & a Roth IRA?
- How to Contribute Pre-tax Dollars to Your HSA
- Does the 125 Plan Affect My Tax Return?
- Can I Deduct an IRA if I Have a SEP?
- How to Make Pretax Contributions to an IRA
- Things That Will Lower Your AGI