How are contributions to a 401(k) plan treated for tax purposes?

Contributions to a 401(k) plan are made with pre-tax dollars, which means they come out of your paycheck before income taxes are applied. This feature is beneficial because it lowers your taxable income for the year in which the contributions are made. For instance, if your income is $60,000 and you contribute $5,000 to your 401(k), your taxable income is effectively reduced to $55,000. As a result, you pay less in federal income taxes for that tax year.

This tax treatment allows individuals to save for retirement while also receiving an immediate tax benefit. Taxes on the contributions and any earnings generated within the 401(k) are deferred until withdrawal, typically during retirement when individuals may be in a lower tax bracket.

The other options do not accurately reflect how 401(k) contributions are taxed. Some contributions can indeed be made with after-tax dollars (Roth 401(k) contributions), but they are not the standard type of contributions for all 401(k) plans. Immediate taxation would mean the contributions have no tax advantage, which contradicts the purpose of retirement accounts. Lastly, tax deductions for contributions are taken in the year they are made, not in future years.