Do my 401(k) contributions lower my income?
I contribute a large portion of my income into a 401(k). I recently applied for benefits that have income limits and I was denied these benefits because I make too much money. I was under the understanding that contributing to my 401(k) lowers my income because that portion will not count as income until in the future when I withdraw it. Am I wrong?
I see you already have eight answers and I'm hoping I'm not simply piling on what others have already shared with you. The point you may be missing is that there is a difference between income and taxable income. Taxable income from employment on your form W-2 includes your gross income less the 401(k) contributions and possibly less some other pretax items. So in effect, if you had an income of $70,000 this year and could put away $10,500 in your 401(k), your income for the year is still $70,000 but your taxable income is only $59,500. This may be the reason you were rejected and leads me to believe that you have to check the rules to determine what each organization uses to qualify or fail to qualify for benefits. What you are doing with the 401(k) plan is shifting income from the current tax year into a year in which you may well be retired. In theory, the typical goal involves moving money out of a higher tax bracket with the expectation that when you retire you will be in a lower tax bracket. I frankly don't know where this theory has come from because in the best of all situations, you've had the use of money that would've gone to Uncle Sam (taxes) over your working lifetime and this money earns additional funds that you would never have had. Paying it back after age 70 1/2 is simply the price you pay for the deduction in the years in which he worked. In the best of all worlds, your retirement income would be much higher but this is often not the case. Hope this helps a little and good luck
I think the issue is due to confusing gross income and taxable income. When you contribute to a 401(k) retirement account you are making a pre-tax contribution, thereby not paying tax on the money today. Under the retirement rules the money grows tax deferred until the day you make withdrawals, then you are taxed on the amounts you withdraw during that year. Your gross income does not change, just taxable income. As an example if you earn $100,000 (gross Income) and you contribute $15,000 to your 401(K), your taxable income will be $85,000, but your gross income is still (remains) $100,000. If you check your year end W-2 or 1099 statements you will see how the taxable income and gross income are entered.
Another term you may encounter for benefits is Adjusted Gross Income which is your gross income minus adjustments to income, which is located on the bottom of the first page of you tax return.
While your taxable income is reduced by your 401(k) contributions, most social benefits and college financial aid applications add the contribution amount back into your taxable income in order to establish your true income. That is what it sounds like you are facing. So, you are getting being taxed on less but it does not reduce your income for benefits. Two different calculations.
Contributing to your 401(k) plan reduces your "taxable" income which means it reduced the amount of income you have to pay taxes on. If you applied for benefits that have income limits they might be looking at your "gross income" as opposed to "taxable income".
I'd need more info to give you a definitive answer. But, 401(k) contributions do reduce your gross taxable income up to $18k/yr if you are under age 50, $24k/yr if over age 50. When you applied for these benefits, there's a chance you are still above their income limits AFTER making contributions, even if you maxed them out. Or, the organization providing the benefits is not taking into consideration any retirement plan contributions you make. There's also a chance you did not take advantage of maxing out your contributions when you were in a position to do so. Hopefully, this helps you determine which number they're using for determining benefits income limits.