Did you know that how you save your money can affect your bottom line? For instance, if you're eligible, placing a portion of your pre-tax earnings into your company's qualified retirement plan (e.g., a 401(k) plan) can increase your disposable income in addition to providing you with the opportunity to save for retirement. Here's a hypothetical example of how it works.
Bill Walsh is a single taxpayer who has an annual salary of $50,000. He consistently saves $5,000 per year and places it in a bank account. Recently, he became eligible to contribute to his company's 401(k) plan. Now, instead of making after-tax contributions to his savings account, Bill decides to make a pre-tax contribution of $5,000 into his 401(k). As a result, Bill reduces his taxable income to $45,000. Assuming a 25% federal income tax rate, such a strategy will give Bill $1,350 more in after-tax income. The following chart shows the details.
| Traditional Saving | 401(k) Plan | |
|---|---|---|
| Gross Income | $50,000 | $50,000 |
| 401(k) Contribution | - $0 | - $5,000 |
| ====== | ====== | |
| Adjusted Gross Income | $50,000 | $45,000 |
| Federal Income Taxes* | $12,500 | $11,250 |
| $ Earmarked for Savings | - $5,000 | - $0 |
| ====== | ====== | |
| Disposable Income | $32,500 | $33,750 |
Savings ---- = $1,250
* Single filer
CRN200802-2013269
