Whereas a Roth 401(k) retirement plan is structured so you make contributions with after-tax dollars, a traditional 401(k) plan allows you to make contributions with pretax money. If you have the latter, your employer subtracts your contributions from your gross income before deducting the required taxes. The Internal Revenue Service has standard requirements for calculating federal taxes on pretax contributions, but state and local laws might vary.
Determine your gross wages. This is your entire earnings for the pay period before any taxes are taken out.
Subtract your 401(k) contributions from gross income before calculating federal income tax – this is the only federal withholding tax that pretax 401(k) contributions are exempt from. For example, your gross salary for the biweekly pay period is $2,000 and you elect to defer 6 percent to your 401(k) plan. Your biweekly 401(k) contributions equal $120, leaving $1,880 of your salary subject to federal income tax. To determine federal income tax withholding, consult IRS Circular E for the tax-withholding table that matches the allowances and filing status on your W-4 form and your wages and pay period.
Figure out your Medicare and Social Security taxes based on your gross wages. These two federal taxes are not exempt from pretax 401(k) withholding. For example, as of 2012, your gross salary of $2,000 would be subject to Social Security tax at 4.2 percent and Medicare tax at 1.45 percent. The 2012 annual wage limit for Social Security tax is $110,100, while Medicare tax is withheld from all earnings.
Contact your state revenue agency for pretax 401(k) regulations, if applicable. Many states do not require 401(k) contributions to be included in wages for state income tax withholding, but a few do. For example, in Pennsylvania, employers are required to include 401(k) contributions as taxable wages for state income tax withholding purposes. Also, the city of Pittsburgh requires local income tax withholding on pretax 401(k) contributions.
Calculate additional withholding, if applicable. A few states require employees to pay additional taxes or insurance. For example, in California, along with personal income tax, employers must withhold state disability insurance from employees’ wages. While pretax 401(k) contributions are not subject to personal income tax in California, they are subject to state disability insurance.
Section 125 or cafeteria plans, such as pretax medical, dental and group-term life insurance are not subject to federal income tax, Medicare tax, Social Security tax, and in many cases, state and local income tax. Deduct the premiums from gross wages before calculating those taxes.
Your pretax 401(k) contributions are subject to federal income tax when you withdraw from the plan; state and local taxes apply if they were not paid at the time of contribution. However, you do not pay Medicare and Social Security taxes or any other taxes that you paid at the time of the contribution. If your employer matches your contributions, the matching amounts are made in pretax dollars and are subject to applicable taxes when you withdraw from the plan.
- Patriot Software: What Are Taxable Wages?
- IRS.gov: 401(k) Plans
- Pennsylvania Department of Revenue: Are My Contributions to a 401(k) Plan Excluded From Employer Withholding?
- Pittsburgh Department of Finance: FAQ - Business and Wage Tax
- California Employment Development Department: Taxability of Employee Benefits
- Social Security Administration: 2012 Social Security Tax Rate and Maximum Taxable Earnings
- IRS.gov: 401(k) Resource Guide - Plan Sponsors - 401(k) Plan Overview