How your 401(k) impacts your taxes

If you’re contributing to a 401(k), making the maximum contribution lowers your taxable income, a huge benefit to taxpayers.

“401(k) contributions are pre-tax contributions and what that means is that any amount that you contribute towards your 401(k) is taken out of your gross income,” says Lydia Vercelli, a certified public accountant in New York City. The more you contribute, the lower your taxable income will be.

For the 2018 tax year, you can contribute a maximum of $18,500 to a 401(k) account if you’re under 50. In 2019, the limit will increase to $19,000. If you’re over 50, your maximum contribution climbs to $24,500 for the 2018 tax year. Next year, the contributions will be capped at $25,000.

You should be maxing out your contributions each year, and taking advantage of your company’s match program, Vercelli says. “That's attractive because it's additional dollars that the employer contributes on your behalf,” she says. Essentially, it’s free money going to your retirement savings.

You can start taking distributions from your 401(k) account at 59 ½, and at that point, those distributions will be taxed like regular income. Because you may not be working, you’ll be in a lower tax bracket, so your tax rate will most likely be lower. If you want to wait and continue contributing to retirement, you can do that until 70 ½. At that point, you must begin withdrawing from your account, and the money will be taxed at that time.

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