Question

Daniel is a new employee looking at contributing to a 401(k) offered through the company. How will his contributions affect his tax liability?

Lower federal income tax

No change to tax liability

No change to FICA tax liability

Increase tax liability

Answer 1

Daniel is a new employee looking at contributing to a 401(k) offered through the company. How will his contributions affect his tax liability?

Ans: Lower federal income tax

Brief description about 401K plan :

Contributions to a qualified 401(k) may lower your tax bill and help you build financial security. You can contribute to up to $17,500 to your 401(k) (or $23,000 if you are age 50 or older by the end of the year). Money contributed to the plan is not included in your taxable income

The contributions you make to your 401(k) plan can reduce your tax liability at the end of the year as well as your tax withholding each pay period. However, you don’t actually take a tax deduction on your income tax return for your 401(k) plan contributions. This is because you receive the benefit of a tax deduction every time you make a contribution with pre-tax dollars

The 401(k) plan contributions you elect to make come directly out of your salary. Since the contributions are made with pre-tax dollars, your employer does not include these amounts in your taxable income for the year. At the end of the year, when you receive your W-2 form that shows your earnings, you will notice that your wages subject to federal income tax are lower because of your 401(k) plan contributions. Since the wages are not counted in your taxable income to begin with, you do not take a deduction when you file your return. However, when you prepare your tax return, it’s possible to calculate how much income tax your 401(k) contributions saved you.