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Can I Take a Tax Deduction for My 401k Contributions?
The short answer here is…no. There is no tax deduction available for 401k contributions. Your contributions have already been deducted on your W-2 from your federal income so you can't deduct them again. They have been taken out of your paycheck, so these assets were never included in your taxable income in the first place.
Deferred Taxes on 401k
One of the key benefits of a 401k plan is the opportunity for the participant to grow his or her money tax-deferred.
Tax deferral is simply the postponement of paying the IRS what they have declared is due them. For example, if you have $10,000 in a 401k account and the account grows to $12,000, then you have income of $2,000. But since a 401k is a tax-deferred account, 401k taxes on growth, gains, dividends, and interest are postponed until a later date.
Taxes on 401k Withdrawals at Retirement
If you choose to do a qualified direct rollover and move your funds to a traditional IRA, then there will be no tax or penalty. Funds are simply rolled out of your 401k and into your IRA.
But, if you do not execute a rollover into an IRA, lump-sum distributions or periodic distributions from your 401k will be taxed at ordinary income tax rates.
Remember this, though. For lump-sum distributions the 401k plan provider is required to withhold 20% from your total distribution. The withholding component is non-negotiable…because the IRS says so.
After receiving distributions from your 401k plan you should receive a 1099 tax form in the following year. The 1099 tax form details the distribution information and the taxes withheld and paid to the IRS on your behalf.
When calculating your taxes, these 1099 figures are plugged into your 1040 tax form, and if more taxes are due, you pay. If the 20% withholding amount was too much, you may get some back. The end result is that your 401k distributions are based upon your marginal tax rate.
In addition to the above ordinary income taxes, remember that premature distributions are generally penalized at a rate of 10%. This tax is due regardless of your personal tax rate.
As a side note, it is important to remember that eventually, the funds will be taxed. Whether it is when you take distributions out of a 401k or when funds come out of an IRA at a later date, the money will be taxed.
Often, a retiree will roll his/her 401k funds into an IRA. Later, upon reaching the age of 70½, distributions from these funds are required to come out. At this point they are taxed at ordinary income tax rates to the owner.
Retirement Savings Contribution Credit
For 2011, you may be able to claim the retirement savings credit if your modified adjusted gross income is not more than:
The IRS calls this a “retirement savings contributions credit” and you could be eligible if you make eligible contributions to a 401k, or a 403b. You may be able to take a credit of up to $1,000 (up to $2,000 if filing jointly).
The amount of the credit you can get is based on the contributions you make and your credit rate. Your credit rate can be as low as 10% or as high as 50%.
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