Retirement Costs Less with a 401k

If you choose a regular 401k, the federal government, and possibly your state government, takes some of the bite out of saving for your retirement. Cutting back your take-home pay to prepare for a distant retirement is a hard decision for many people, but it’s not as expensive as it seems. Money that goes into your regular 401k is not taxed, so you’ll have less withholding from your paycheck. People in the 30 percent tax bracket find that every $100 that goes into the 401k only costs $70 of take-home pay. That’s because, when the $100 is “paid” to you, $30 of it goes to the government, and only $70 finds its way to your paycheck. This is why contributing to your 401k doesn’t cost as much as it seems.

To do the arithmetic yourself, you need to know your federal tax bracket. If you live where there’s a state personal income tax, add the state tax bracket. A few cities also levy income taxes. It’s important to use your “marginal tax rate” rather than average tax rate. The marginal rate is the tax on an additional dollar of income. This is different from your average tax rate, which is the total dollars you pay in tax divided by your total income.

At the federal level, your marginal rate may be as low as ten percent or as high as 39 percent. State tax rates range from one percent up to ten percent. To find your marginal tax rate, first find your “taxable income.” Here’s where to find it, based on the kind of tax return you filed.

If you filed form 1040, line 43 if you filed form 1040A, line 27 if you filed form 1040EZ, line 6
A full table of tax rates is available on the Internal Revenue Service’s web site. Simply search for “IRS federal tax rate schedules” plus the year. Here are the 2008 tax brackets for joint returns, the most common type of tax return:

$0 – $16,050, tax rate is 10.0%
$16,051 – $65,100, tax rate is 15.0%
$65,101 – $131,450, tax rate is 25.0%
$131,451 – $200,300, tax rate is 28.0%
$200,301 – $357,700, tax rate is 33.0%
$357,701 & Over, tax rate is 35.0%

Don’t forget to add in your state tax rate. There are too many state tax rates for me to publish them all, but your state tax instructions will probably be helpful. A general guided to state taxes is available from the Federation of Tax Administrators. If you have any doubt about contributing to your 401k, keep this good news in mind. Tax benefits are one of the great advantages of saving for retirement through your 401k.