Contributing pre tax dollars to your retirement plan can offer you some significant tax breaks. The reason is the difference between before-tax savings (in the Plan) and after-tax savings (in a bank, for example). Let's assume your eligible annual pay (and your total taxable wages before retirement plan deductions) is $30,000, you are single and take the standard deduction. Here's an example of how your tax savings might be calculated using 2021 tax laws.
| After-Tax Contributions | Before-Tax Contributions |
Annual pay | $30,000 | $30,000 |
Before-tax contributions (6%) | - 0 | - $1,800 |
Taxable Income | $30,000 | $28,200 |
Estimated federal income taxes | - 1,895 | - 1,679 |
After-tax savings (6%) | - 1,800 | - 0 |
Your remaining pay | $26,305 | $26,521 |
Tax savings | $0 | $216 |
Estimated federal income taxes are based on 2021 tax tables and the standard deduction. State income taxes have not been included but could represent additional savings if you would have otherwise paid state tax on the money you contribute to your Plan account. Deferral rate is assumed to be consistent throughout the year. FICA taxes are not reduced by contributions to the Plan.
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