Easing the Bite of 401(k) Contributions

We all know we should be contributing as much as we possibly can to our 401(k)s. There's really no excuse not to. No matter how well you do with your other investments, you're unlikely to beat the 401(k)s advantages of tax-deferred growth and a company match. The bottom line: Max out.

So why don't we do it? Well, we've got tuition bills, car-loan payments, credit-card debt, medical bills, mortgages, etc., etc., etc. Fact is, most of us really don't want to see our paychecks shrink any further — even if it's going to give us a more comfy retirement. That's why we developed this 401(k) contribution calculator. If you really crunch the numbers, the results may pleasantly surprise you. What most people don't realize is that increased contributions usually mean lower federal and state income taxes. Why? Because all or part of your increased contributions will generally be deducted from your taxable salary. What's it mean? The net amount in your paycheck may actually decline by a good deal less than the additional amount you choose to contribute.

There are a few things to remember, however.

First, your 401(k) pay-ins — termed "salary reduction contributions" or "elective deferrals" by tax wonks — remain subject to Social Security and Medicare taxes, which are 7.65% of your salary up to $97,500 for 2007 and 1.45% after that.

Also, pretax contributions for 2007 are limited to no more than $15,500 ($20,500 if you will be age 50 or older at year-end) although your plan may impose a lower limit based on a percentage of your salary. That said, some employers also allow you to make after-tax contributions above the applicable percentage limitation. But beware: These types of contributions will reduce your take-home pay dollar for dollar. For example, say your salary is $115,000 and your plan allows you to contribute up to 15% of compensation. If you contribute the full $17,250, the last $3,250 will be with after-tax dollars because you have exceeded the federal $15,500 salary-reduction limit. Our calculator takes this factor into consideration. And since you are still able to defer taxes on the earnings generated by these contributions, making after-tax contributions isn't a bad idea (assuming you can afford it).