When you land your first job with an employer that offers a 401(k) plan, you'll need to know how the plan works and how you should make your payments. Your employer might provide only a traditional plan that lets you fund your account on a pretax basis, or it can include a Roth feature that allows after-tax payments. In either case, your payments are deducted straight from your paychecks.
How 401(k) Deductions Work
Under Internal Revenue Service rules, your employer must establish a 401(k) plan document that explains the day-to-day operations of the plan. The document includes eligibility requirements that employees must meet to participate in the plan. When you enroll in the plan, your employer gives you a copy of the summary plan description. If you’re eligible to participate in the plan, you'll follow your employer’s instructions to sign up and elect in writing your paycheck deduction amount, such as 3 percent of your gross pay, or a specific amount such as $60. Your employer then deducts that amount from your wages each pay period until you reach the annual contribution limit as mandated by the IRS.
Pretax and After-Tax Deductions
If you make your payments with pretax money, your employer doesn't take any federal income tax out of your deductions; you pay this tax when you withdraw from the plan. Your employer must take Social Security and Medicare out of your payments. This means that you get a tax break on your federal income tax withholding, but not on your Social Security and Medicare withholding. If your employer offers an after-tax 401(k) plan, also called a Roth IRA, your payments are made on an after-tax basis. In this case, your employer takes all taxes, including federal income tax, out of your deductions. You do not pay federal taxes on your Roth payments upon withdrawal.
Reporting 401(k) Payments on Your W-2
Box 1 of your annual W-2 stands for your federal taxable gross wages. Because no federal income tax came out of your pretax 401(k) payments, your employer should not report your payments in Box 1. For informational purposes, your employer may put your pretax payments in Box 12 of your W-2. If you have a Roth plan, your payments would be included in Box 1 because they were subject to federal income tax.
Changing or Stopping Your Payments
Your summary plan description should state how frequently you can change your paycheck deduction amount and whether you can stop contributing to the plan. You may be able to stop your deductions or change the amount at any time, provided you complete and submit the appropriate forms to your employer.
Grace Ferguson has been writing professionally since 2009. With 10 years of experience in employee benefits and payroll administration, Ferguson has written extensively on topics relating to employment and finance. A research writer as well, she has been published in The Sage Encyclopedia and Mission Bell Media.