401K Deduction (not contribution) Question

[NiceGuyEddie]

OK, so...

We all know that if you make $50K and save $10K to your 401K, your taxable income is $40K.

But I heard there is a limit - if you make say $100K and save $20K your taxable income is NOT $80K, it might be $90K.

After maximum tax deduction, you may want to do something else with your money.

I can't find any charts anywhere about this, but it might be because I am WRONG.

[delta0014]

There’s a limit of how much you can contribute but it’s all pre-tax.

[shmelty]

The maximum amount you can contribute in 2020 to a 401(k) as an employee is $19,500. That is $500 more than the 401(k) limit for 2019. If you are 50, or older, you can also make a catch-up contribution.

[PaulProe]

Not an expert on Tax Code, but I did run into this

Depending on the size of your company, the number in the plan, your salary in relation to all of them and to the company as a whole, you may run into a highly compensated employee rule, where you can only contribute x% more than the others. Your HR department should be able to help

[ptbashor]

The maximum amount you can contribute in 2020 to a 401(k) as an employee is $19,500. That is $500 more than the 401(k) limit for 2019. If you are 50, or older, you can also make a catch-up contribution.

Shmelty has is correct, the current max contribution this year is $19,500, it changes every year.

[NiceGuyEddie]

Hello Friends:

Thanks for the responses, but it looks like I didn't phrase my question properly. I do understand the max contribution and also the max contribution if you are 50 or over.

What I mean is there is a point where you can only deduct so much from your taxable income. Allegedly. Somebody told me this years ago when I was a wee lad, or at least I think so.

I work for a small company and the plan is brand new, so nobody at work knows the answer. A rep from the investment company came in yesterday and he didn't know the answer to my question. Imagine that.

[sread]

you may be thinking about the phase out limits for deductibility of IRA contributions over a certain income threshold - I am pretty sure there are no such limits for 401 k contributions.

[mike223]

What I mean is there is a point where you can only deduct so much from your taxable income. Allegedly. Somebody told me this years ago when I was a wee lad, or at least I think so.

401k is a deferral of taxes, not a deduction.

You could defer 100% of your compensation, as long as that figure does not exceed the annual limits discussed above.

See "Basic elective deferral limit" linked below.


https://www.irs.gov/retirement-plans...-contributions


Does that answer your question?

[Mike N]

Eddie.

Read this: https://www.irs.gov/retirement-plans...-plan-overview Specifically the difference between traditional and safe harbor 401K plans. I think this may be what you're remembering. My company uses the safe harbor approach.

[RJD]

For 2019, the 401(k) tax deferral is phased out in increments for single taxpayers with an income in the range of $64,000 to $74,000. Married filing jointly - $103,000 to to $123,000.

[mike223]

For 2019, the 401(k) tax deferral is phased out in increments for single taxpayers with an income in the range of $64,000 to $74,000. Married filing jointly - $103,000 to to $123,000.

Negative - that is the phase out on IRA deductions - not 401(k) deferrals.

[NiceGuyEddie]

Bummer on the above being negative, I thought we were getting close.

Since we don't have an answer yet, I must be wrong in what I recollected.

Every time I google "maximum 401K deduction" all that comes up is info about the contribution.

It must be linear, the deduction is always equal to the contribution, regardless of total yearly income.

In any case, I follow the:

Step 1. Contribute to company 401K up to the match
Step 2. Contribute to a Roth IRA
Step 3. If you max the Roth IRA of $6,000 go back to the 401K

[delta0014]

Yearly income does not matter for 401k contributions, IRA does have an income limit..

All 401k contributions are pre-tax. It’s not a deduction like say mortgage interest. You’re only deferring the taxes until you withdraw in retirement.

[mike223]

In any case, I follow the:

Step 1. Contribute to company 401K up to the match
Step 2. Contribute to a Roth IRA
Step 3. If you max the Roth IRA of $6,000 go back to the 401K

Good plan.

At least until they change the rules - yet again - who knows? - answer: "nobody"...


It's exhausting.


Good Luck.

[RJD]

Negative - that is the phase out on IRA deductions - not 401(k) deferrals.

Negative on the negative. A 401(k) is a form of an individual retirement account (IRA). Those income ranges in the previous post cause the tax deferrals on your 401(k) contributions to phase out. When phased out, your contributions to your 401(k) for the year are not excluded from your taxable income for that year like they would have been had your income been below the phase out limits.

See below, particularly the last paragraph and first two bullets.

67DEA3CF-B051-408F-A494-10315253779F.png

[mike223]

Negative on the negative. A 401(k) is a form of an individual retirement account (IRA). Those income ranges in the previous post cause the tax deferrals on your 401(k) contributions to phase out. When phased out, your contributions to your 401(k) for the year are not excluded from your taxable income for that year like they would have been had your income been below the phase out limits.

See below, particularly the last paragraph and first two bullets.

Wrong again - you are confusing deferrals and deductions.

Let me highlight where the IRS changed subjects among their "Highlights of changes for 2020":

The income ranges for determining eligibility to make deductible contributions to traditional Individual Retirement Arrangements (IRAs), to contribute to Roth IRAs and to claim the Saver's Credit all increased for 2020.



A 401(k) is simply not a "traditional" IRA, nor a Roth - they are covered by different rules.


The instructions for form W2 make the 401(k) question perfectly clear on page 16: https://www.irs.gov/pub/irs-pdf/iw2w3.pdf


"Box 1—Wages, tips, other compensation. Show the
total taxable wages, tips, and other compensation that you
paid to your employee during the year. However, do not
include elective deferrals (such as employee contributions
to a section 401(k) or 403(b) plan) except section 501(c)
(18) contributions."


How could you possibly phase it back in (as taxable income) when it was purposely left out of box 1?

[Jacob McCrea]

"What I mean is there is a point where you can only deduct so much from your taxable income."

There is no such thing as a "401k deduction," because the money needs to be treated as "income" before you can take a deduction from "income," and the 401k contribution is not treated as "income." The language Mike quotes above is consistent with this.

This assumes your contribution is within the yearly contribution limited, which is correctly stated above. I have no idea what would happen if one tried to contribute more than the yearly limit to a 401K plan. I looked into the same question for an IRA account, and as far as I could tell you'd risk paying tax on the excess contribution twice - once before it went in, and again when it came out - at which point you may as well spend it on a kit car.

[RJD]

[QUOTE=mike223;400156]The instructions for form W2 make the 401(k) question perfectly clear on page 16: https://www.irs.gov/pub/irs-pdf/iw2w3.pdf


"Box 1—Wages, tips, other compensation. Show the
total taxable wages, tips, and other compensation that you
paid to your employee during the year. However, do not
include elective deferrals (such as employee contributions
to a section 401(k) or 403(b) plan) except section 501(c)
(18) contributions."


How could you possibly phase it back in (as taxable income) when it was purposely left out of box 1?[/QUOTE

Sorry, have to disagree with you again. When you do your taxes - that's when your final tax is determined based on your final taxable income. If you find you've hit that phase out income threshold when you do your taxes at the end of the tax year, you'll notice as you work through the forms that the amount you contributed to your 401(k) is now included as taxable income.

Too bad we just can't go to a flat tax scheme - that'll give us more time in the garage and less time on taxes.

[chargerbill]

The annual contribution that you personally can contribute is $19,500 (this sum is not taxable).
Keep in mind that your employer contributions are not included in that annual limit (this sum is taxable).
Your annual contribution may exceed $19,500 if you include both personal and employer contributions.

Hope this helps.

[mike223]

When you do your taxes - <snip> you'll notice as you work through the forms that the amount you contributed to your 401(k) is now included as taxable income.

Too bad we just can't go to a flat tax scheme - that'll give us more time in the garage and less time on taxes.

Agreed on spending way too much time on taxes.


Let's try this - I can show you the worksheets for phasing out deductions on traditional IRAs and eligibility for Roth IRA contributions.

They are worksheets 1-2 and 2-1 in Pub 590A here: https://www.irs.gov/pub/irs-pdf/p590a.pdf




If you would kindly point me to a Pub and worksheet for phasing out 401(k) deferrals - I would appreciate that information greatly.

It's something I need to know.

[mike223]

Maybe this IRS comparison chart provides more clarity?

https://www.irs.gov/retirement-plans...mparison-chart

[NiceGuyEddie]

It looks like I sent everyone on a wild goose chase and I apologize. Still good learning, though and since it's related we can discuss further:

Even though I read it over and over again, I don't understand the term "phase out."

[NiceGuyEddie]

.... I have no idea what would happen if one tried to contribute more than the yearly limit to a 401K plan.

This once happened to me accidentally. The extra money automatically got put into the same investment funds as an Individual Taxable IRA. They give you a warning and you can move the money around, but if you do nothing this is what happens.

[mike223]

Even though I read it over and over again, I don't understand the term "phase out."

I'll try.

This specific example is for deducting an IRA contribution.

If you're filing single and your adjusted gross income is $64,000 or less - the full amount of the IRA contribution is deductible.

Same situation AGI is $74,000 or more - the contribution is not deductible.

The deduction phases out from from 100% deductible at $64,000 AGI to 0% deductible at $74,000 AGI - Presumably it's around 50% deductible at $69,000 (figuring the exact number is what the worksheet is for).


Hope that helps.

[mike223]

Another term is "phase in".

Similar example - if you don't make a lot of money, you probably don't owe tax on long term capital gains, provided you don't make a bunch of money on those long term capital gains (sale of privately held stock, etc).

But at some income level they start stepping up from charging 0% tax to 100% of whatever the tax rate would be for that particular situation.

And there are worksheets for all of that.


And sometimes three weeks of research and paperwork just to get to the point of concluding whether you owe tax on it or not, or how much.

[Papa]

If you look at what your AGI is, it is the sum of all your income less any pre-tax deductions. If you contribute to a 401k, you will see at difference on your W2 in your wages (box 1) vs. your Social Security Wages (box 3). That difference is what you contributed to "qualified" tax-deferred plans. My wife and I exceeded the limits shown in one of the posts above, and it didn't affect our AGI. The important thing is to recognize your tax savings. Say you contribute 10,000 into your 401k and your tax rate is 23%. That means you saved 23% of $10,000 or $2,300 that you would have otherwise paid tax on.

Don't forget about your HSA is you have one. A family can defer up to $7,100 ($8,100 if 55 or older) into their HSA in addition to the 401k contributions you are allowed to make. HSA's are pre-tax when contributed to, not tasked when you use the funds for qualified medical expenses, and they are not taxed on any dividends/interest or other gains when invested if your plan allows for it.