Tax Experts
Boost Savings While Cutting Taxes
Contributing to a 401(k) reduces the amount of income that can be taxed.
By Kevin McCormally, Editorial Director, Kiplinger.com
March 2, 2007
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I've gotten a much larger-than-expected raise for 2007. How does increasing my 401(k) contribution help reduce my tax bill?
Kevin responds:
Every dollar you put in your 401(k) reduces your 2007 taxable income by $1 and your federal tax liability by $1 multiplied by your tax bracket.
If you're in the 28% bracket with your new raise, then an extra $1,000 into the 401(k) will cut your tax bill by $280. The 28% bracket starts when taxable income for 2007 exceeds $128,500 on a joint return. The bracket below that (running from $63,700 to $128,500) is the 25% bracket. An extra $1,000 into the 401(k) would save you $250. If your state has an income tax, there will be state income tax savings, too.
For 2007, someone age 50 and older can contribute up to $20,500 to a 401(k). That limit does not include any company match. Before you increase your contributions to the maximum, you may want to ask a plan administrator if there are any restrictions that might limit your contributions to less than the federal maximum. Certain "highly compensated employees" (those making more than $100,000 in 2007) are sometimes limited based on how much other employees contribute to the plan.
See the previous question and answer and our archive of questions and answers.