401(k) Tax Advantages

Investing in a 401(k) has some significant tax advantages for you. These tax advantages are provided for you by the government as an incentive for you to fund your own retirement. The government needs as many people as possible to fund their own retirement as they cannot afford to fund everyone's retirement. If this was the case you would have much larger deficits than what there is today, you would have a nation of retired people living at or below the poverty line which in turns affects the economy and the social unrest within society. Politically this would be poison for any party.

Income tax benefits are the incentives that the government is providing you whilst you have income earning capacity. There is the offset that you do not have to pay any income tax on your pre-tax contributions until you have withdraw your funds from your 401(k) plan, which hopefully is when you have retired. The government also provides for a tax deferral on any earnings you have made from your 401(k) investments until you withdraw from your 401(k) plan. The reduction in your gross income from investing in to 401(k) has a follow on effect to all other government income taxes that are applied at the federal, state or local level.

This income that you have invested as pre-tax dollars has a snow ball effect on accumulating more retirement funds. This is known as compounding your investment. As an example to save $15,000 and you are not investing in 401(k), it takes approximately $24,000 in pre-tax income. On the other hand if you are investing in 401(k) it will only take approximately $16,000 in pre-tax income. That's a big difference.

If you live in the right state, then they also may provide you with the benefit of not paying taxes on the contributions you make to 401(k). The odds are you are living in the right state as most states provide this benefit. There are some taxes you will have to continue to pay whilst you are receiving these tax benefits for 401(k), these taxes are for unemployment, Social Security and Medicare.