How do taxes affect 401(k) contributions?

Employee contributions to a 401(k) are tax-deferred, not tax-free.

  • Employee contributions are pre-tax deductions that reduce taxable income.
  • Funds in a 401(k) accumulate tax-free until they are withdrawn for use in retirement.
  • Withdrawals from a 401(k) are then taxed as income. Some withdrawals before retirement age are also subject to excise taxes.
  • The exception is for designated Roth deferrals, which are elective deferrals that the participant elects to include in gross income.

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