A pretax contribution allows you to postpone taxes until you take the money out, usually when you retire. For instance, if you save $10,000 from your salary for a traditional 401(k) plan in 2024, you won’t pay income taxes on that $10,000 in 2024. You will owe taxes when you withdraw the money (including contributions, earnings, and any employer match) in retirement, whether that’s in 2034, 2044, or 2074.
This differs from after-tax contributions and Roth contributions. Many tax-advantaged accounts accept pretax contributions, such as traditional 401(k)s (not Roth), Individual Retirement Accounts (IRAs), and also 403(b) and 457 plans.
Is Pretax Contribution Worth It?
Many investors benefit from making pretax contributions because they save on taxes. By contributing pretax, you lower your taxable income, which means you pay less in taxes.
You could think about saving for retirement with a Roth account instead. Your choice depends on whether you think your tax rate will be lower when you retire. If you believe it will be lower, then pretax is the way to go. If not, choose a Roth account.
You shouldn’t focus on saving for retirement if you have high-interest debt like credit card debt. The high interest can erase any tax benefits you might gain.
How Much Should You Invest It?
Fidelity suggests that people save 18% of their income before taxes each year to get ready for retirement starting at age 67. This advice assumes you began saving at age 30. If you started at 25, you should save 15%. If you started at 35, aim for 23%.
These numbers include what your employer contributes. They expect you will receive Social Security benefits and do not have a pension, which is common now since many companies are moving from pensions to 401(k) plans.
Conclusion
Pretax contributions let you set aside money for a retirement plan without paying payroll or income taxes on that income.
Contributions made before taxes lower your taxable income right now, which means you pay less in taxes now. These taxes are postponed. You will pay income tax on your contributions and earnings when you take money out of the account, usually during retirement.