When you save pre-tax money in your retirement plan, you don’t pay taxes until you withdraw it.
Lower your taxes as you save
Pretty much all retirement plan participants make pre-tax contributions. The money you save in the plan doesn’t count as taxable income. So you’ll owe less in taxes as you save.
When you withdraw the money, which hopefully won’t happen until you retire, you’ll owe regular federal, state, and local income tax on your contributions and any earnings.
- Caution: If you withdraw any money before age 59½, you’ll owe a 10% federal tax penalty in addition to your regular taxes unless an exemption applies.
Have a happier paycheck
Remember your first real paycheck? Wasn’t it kind of a bummer to see your gross pay reduced by all those withholdings that you had never heard of before? Pre-tax contributions soften some of those hits.
Your pre-tax contributions are deducted from your income before federal taxes are withheld. This means that the amount taken out of your paycheck goes down. For example, if you make $50,000 per year and save 10% pre-tax, your federal withholding goes down by $48 per paycheck.