More Take-Home Pay If You Increase 401k Contribution?
Kevin thinks that he'll get more take-home pay by adding more contribution to his 401k because of the tax benefit, but Dave breaks it down for him.
QUESTION: Kevin asks if he’ll end up with more take-home pay by putting more money into his 401-K. He was told he’ll have a lower taxable income if he does that. Is that correct?
ANSWER: It will bring your taxable income down by the amount which you put into the 401-K. You will not have an increase in take-home pay because you’ll be putting more into your 401-K.
Here’s an example. If you’re in a 25% tax bracket, meaning that 25% of the money you make goes to taxes, and you put $1,000 into your 401-K, you are not taxed on that amount. So, you reduced your take-home pay by $1,000, but you also reduced your tax bill by $250.
It’s not a one-for-one deal meaning that you don’t get a $1,000 tax break because you put $1,000 more in your 401-K. Your tax rate determines that.