What Is a 401(k) Tax Deduction?

Understanding the Basics

A 401(k) tax deduction refers to the reduction in your taxable income when you make pre-tax contributions to a traditional 401(k) retirement account. Therefore, you pay less tax now, the money grows tax-deferred inside the account, and you’ll only be taxed when you take it out in retirement.

Traditional vs. Roth 401(k) Contributions

The primary difference between traditional and Roth 401(k) is that contributions to a traditional 401(k) are made pre-tax. The money is taken from your paycheck before federal income taxes are calculated. As a result, you owe less income tax right now, giving you immediate savings. 

In a Roth 401(k), there are no upfront deductions. Instead, qualified withdrawals (usually those made after age 59½ and once you’ve had the account for at least five years) allow both your contributions and investment growth to come out tax-free.

In a traditional 401(k), your money grows tax-deferred, meaning you don’t pay taxes on contributions or earnings until you withdraw them in retirement. 

The choice between the two comes down to whether you think your tax rate will be better today or later in retirement. 

How 401(k) Contributions Affect Your Taxes in 2026

Contribution Limits for 2026

The Internal Revenue Service (IRS) has announced the new contribution limits for 2026, as follows:

The employee contribution limit (for employees under 50 years old) is now $24,500, up from $23,500 in 2025. 

Catch-up contributions (age 50+) for 2026 are $8,000. 

Individuals ages 60-63 can contribute up to an additional $11,250 if their plan allows. 

As for employer contributions (what your boss puts in), it is 100% of compensation or a combined total of $72,000, whichever is less.

Example of 401(k) Tax Savings

Let’s say an individual earns $90,000 and contributes $15,000 to their 401(k). Their taxable income is therefore reduced to $75,000, potentially saving over $3,000 in taxes (depending on their tax bracket). 

In practice, the exact savings will depend on your filing status, deductions, and tax bracket, but this shows how powerful pre-tax contributions can be.

Besides short-term savings, pre-tax contributions to a 401(k) mean your investment grows tax-deferred until retirement. 

Let’s assume the annual growth rate is at 7% and you keep it for 25 years. Your $15,000 invested at 7% annually for 25 years will grow to $81,400. 

What’s more, when it comes to withdrawal in retirement, you’re often in a lower tax bracket, so the tax you eventually pay is less than what you avoided upfront.

Key IRS Rules and Considerations for 2026

Required Minimum Distributions (RMDs)

Required Minimum Distributions (RMDs) are mandatory annual withdrawals from tax-deferred retirement accounts, like traditional IRAs, 401(k)s, SEP IRAs, and SIMPLE IRAs.

RMDs are meant to ensure that retirement savings are eventually taxed as regular income.

Under the SECURE 2.0 Act, individuals who turn 73 between 2024 and 2032 (born 1951–1959) must begin taking RMDs in the year they reach age 73, with those withdrawals taxed as ordinary income. 

The age rises to 75 for those born in 1960 or later (effective for distributions after December 31, 2032). 

Early Withdrawal Penalties

Retirement savings are designed for use in retirement. Withdrawals before the age of retirement (59½) typically incur a 10% penalty plus income taxes. This penalty applies to the portion of the distribution included in gross income and is designed to discourage the use of savings for non-retirement purposes.

There are, however, exceptions, such as hardship withdrawals, qualified medical expenses, and separation from service, such as after leaving a job in or after the year you turn age 55. 

Maximizing Your 401(k) Tax Deduction with Butson Financial Advisors, LLC

401(k) accounts are created to help you save money on taxes while also growing your funds for retirement. The best way to maximize the benefits of your retirement savings account is to efficiently use your 401(k) tax deduction to minimize your taxable income. 

Buston Financial Advisors, LLC can assist you in developing a personalized retirement plan to work towards your retirement goals. 

Remember that retirement should be a time to unwind and pursue your passions without worry. By engaging in strategic planning for 2026 and beyond, you can boost your chances of meeting your financial objectives for your ideal retirement lifestyle.

Contact us today, and let’s start planning for your retirement life together!