401(K) and pre-tax basis? Need help please..........................!?

Question

If you can, answer both or you can answer the one you know.
1) What does pre-tax basis and after tax basis mean?
2) 401k is tax deferred till retirement, but u get taxed after that, so what good is it? Why not just tax it now, i mean i dont see any benefits other than some employers matching the 401k contribution

Thanks you for your time :)

Many people assume that a 401(k)'s main advantage is due to the employee being in a lower tax bracket in retirement than during working years, HOW IS THIS POSSIBLE?

Also, 401k plans, do they pay you interest, and if yes, the employer does?

Answer 1

Pre-tax means that neither you nor your employer are paying taxes on the amount of your wages that you contribute to your 401(k) plan. So for example, if you contributed $10,000 to your 401(k) plan in 2006, you did not pay tax on these earnings. The contributions are deducted from your gross wages. Then the remaining wages are taxed.

When youre in youre 60's and may start to take distributions, yes, the amount will be taxed. Most of us at that age will not be working and will be approaching retirement, collecting SS, etc. We will most likely be in a lower tax bracket at that point then we are now. Which means we will pay less tax on the distribution then if we pay tax now on the contribution.

The employers' contributions can be a huge benefit over time. You're getting "free money" and that money is earning interest/dividends, etc. for the next 40+ years. Your 401(k) is an investment, whether in stocks, mutual funds, etc., you will earn interest over time. No, your employer doesnt pay the interest. Your 401(k) is most likely with a financial institution, like Fidelity Investments. They are managing your investments, even though you get to choose which stocks or funds you want to invest in. They will pay out your distribution when the time comes.

Answer 2

The benefit to paying taxes later in a 401k is that you get to invest that amount of money that would normally be spent on taxes. For example, you invest $1,000. If you pay the taxes now you would actually only invest $800 and earn the interest on that amount. If you pay the taxes later, like a 401k or an IRA, you get to invest the entire $1000 and earn interest on all of it.

Also, later on down the road, you will probably be in a lower tax bracket than you are now because you won't be working.

Answer 3

Pretax means that the money you put into the 401(k) is taken out before your taxes are calculated. If for example you make $25,000 in a year but put $1000 into a 401(k), you'd only pay taxes that year on $24,000.

The advantage is that you have more money to invest until you withdraw it after you're retired, so there is more money to grow.

Most 401(k) plans have a number of different investment options. You choose how your money is invested.