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Indestata > Personal Finance > Retirement > Does Contributing to a 401(k) Reduce Taxable Income?
Retirement

Does Contributing to a 401(k) Reduce Taxable Income?

TSP Staff By TSP Staff Last updated: August 7, 2025 7 Min Read
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If you have a retirement account, you are probably wondering, does a 401(k) reduce taxable income? The short answer is yes, contributing to a traditional 401(k) plan does indeed reduce your taxable income for the year of contribution. When you make contributions with pre-tax dollars, the money goes into your retirement account before calculating income taxes on your paycheck. This tax advantage serves as a powerful incentive for retirement savings. It essentially gives you an immediate return on your investment through tax savings.

Ask a financial advisor about how to structure your accounts to minimize your tax burden come tax time.

Tax Benefits of Contributing to a 401(k)

  • Immediate tax deductions. You make contributions to a traditional 401(k) with pre-tax dollars1, reducing your taxable income for the year.
  • Tax-deferred growth. The money in your 401(k) grows tax-free until withdrawal during retirement. This means dividends, interest and capital gains accumulate without annual tax payments. This allows your investments to compound more efficiently over time.
  • Employer matching contributions. Many employers match a percentage of your 401(k) contributions, essentially providing you with free money that also grows tax-deferred. This benefit amplifies your retirement savings while adding another layer of tax-advantaged growth to your portfolio.
  • Roth 401(k) tax-free withdrawals. If your employer offers a Roth 401(k) option, you contribute after-tax dollars but can withdraw the money tax-free in retirement. This is particularly valuable if you expect to be in a higher tax bracket during retirement.
  • Potential tax credits. Lower and middle-income taxpayers may qualify for the Saver’s Credit. This provides a tax credit of up to $1,000 ($2,000 if married) for contributions to retirement accounts.

The tax benefits of contributing to a 401(k) make it one of the most powerful retirement planning tools available. By taking advantage of these incentives, you can significantly reduce your current tax liability while building a substantial nest egg for your future.