The QuestionWill contributing more to my 401k lower my tax bracket? For example, say I make 50k (bracket with 22% rate) and contribute 6k to my Traditional 401k ($44,725 is the max for the bracket with a 12% rate), will I be placed in the lower bracket?
Contributing more to your Traditional 401k can effectively lower your taxable income because contributions are made pre-tax, which means they are not included in your taxable income for the year.
In your specific example, if you earn $50,000 in a year and contribute $6,000 to your Traditional 401k, your taxable income would indeed be reduced to $44,000. However, it’s important to understand that tax brackets in the U.S. are marginal, which means only the income in each bracket is taxed at that bracket’s rate.
To clarify, if your taxable income after the 401k contribution is $44,000, then you’re in the 12% tax bracket, but that doesn’t mean all your income is taxed at 12%. In fact, for tax year 2023, only the income above $11,000 is taxed at 12%, assuming you are a single filer. The income below that is taxed at 10%.
To put it simply, contributing more to your Traditional 401k can lower your taxable income, but it doesn’t necessarily “lower your tax bracket” in the sense that all your income is taxed at a lower rate. It merely reduces the amount of your income that’s subject to the higher tax rate.
Another important thing to consider is that in addition to the income that you contribute to a Traditional 401k, there are other ways to lower your taxable income, including utilizing the standard deduction or itemizing your deductions if it makes sense to do so.
The standard deduction is a specific dollar amount that reduces the income you’re taxed on. For tax year 2023, the standard deduction for a single taxpayer is $13,850. So, if you’re a single filer, you can subtract $13,850 from your income before applying the income tax rates, which could potentially put you in a lower tax bracket.
Itemized deductions are specific expenses that you incurred during the tax year that the IRS allows you to deduct from your taxable income. These can include things like mortgage interest, state and local taxes, medical expenses, and charitable contributions. If the sum of your itemized deductions is higher than the standard deduction, you would usually choose to itemize to reduce your taxable income further.
So in your case, if you earn $50,000, contribute $6,000 to your 401k, and take the standard deduction for a single filer, your taxable income could be reduced to $30,150, placing you solidly in the 12% tax bracket.
My website has some great resources and important numbers. You can view it at www.swadwealth.com/free-resources.
Remember that tax laws are complex and can change often. It’s always a good idea to consult with a tax advisor or accountant to understand how these rules apply to your specific situation.
Hope this helps!
Zack Swad, CFP®, CWS®, BFA™, AWMA®, AAMS®
President & Wealth Manager, Swad Wealth Management, LLC
100 Stony Point Rd, Suite 244, Santa Rosa, CA 95401
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