Retirement plans like 401(k)s and IRAs can be an easy and effective way to save for retirement. Many investors favor these accounts for their significant tax advantages, which can include pre-tax or tax-deductible contributions.
Contributions to a 401(k), traditional IRA, and other retirements plans are usually tax-favorable up to a limit. However, not all retirement plan contributions are. The type of retirement plan you have will determine whether you can reduce your taxable income with your contributions.
Let’s explore how tax advantages vary and when your contributions to retirement savings can reduce taxable income.
Roth vs. Traditional IRA
With traditional IRAs, you make contributions with pre-tax funds. This means your contributions are deducted from your total income each year, reducing your tax obligation for that year. Later on, when you withdraw funds from your traditional retirement account, you’ll pay taxes according to your income bracket.
With this type of IRA, the tax dollars saved reduce your out-of-pocket cost to fund the IRA contribution. In effect, a portion of your tax liability is included in your contribution and allowed to potentially grow over time. This savings option may also be beneficial if you plan to be in a lower tax bracket after retirement.
In contrast, Roth IRA contributions are made with after-tax income, meaning they’re not tax-deductible. Instead, Roth accounts provide tax advantages when you withdraw the funds after you reach age 59½ and have held the account for five or more years. At that time, you can make tax-free and penalty-free withdrawals, including any earnings.
With a Roth, while you need to pay taxes on your contributions, you are not taxed on the additional earnings that can accumulate over time.
How IRA and 401(k) Retirement Plans Work
Contributions to traditional IRAs and 401(k)s are tax-deductible. But with 401(k)s, you don’t need to claim them as deductions on your tax return. Instead, your employer will exclude the amount you contribute from your taxable income.1
How different retirement plan contributions are taxed can also depend on other factors like the plan’s contribution limits, age limits, and income limits.
Contribution Limits
For IRAs, you can contribute up to $7,000 (or $8,000 if you’re 50 or older) for 2025. If you contribute more than this amount, the excess will be taxed at 6% per year for each year it remains in the IRA.2
For 401(k) plans, you can defer up to $23,500 ($31,000 if you’re over 50 or $34,750 if you’re 60-63 as a catch-up contribution, if allowed by your plan) for 2025. With employer contributions included, your account can receive up to $70,000 ($77,500 if you’re ages 50–59 or 64 and older; $81,250 if you’re ages 60–63).2
You can contribute to both a 401(k) and an IRA at the same time. However, contribution limits apply to the total contributions for each type of account, no matter how many accounts you have.
Age Limits
You can start contributing to an IRA at any age if you have taxable income, and there is no maximum age limit. As long as you are earning money, you can continue to contribute even if you are taking required minimum distributions (RMDs).3
For 401(k)s, employers must allow you to participate in their plan (if they have one) after you’ve worked for the company for one year and are 21 or older. The plan may permit participation sooner. Then, you can continue to contribute for as long as you are earning income.4
Income Limits
If you earn above a certain threshold, your tax advantages and contribution limits begin to phase out for certain types of retirement plans.
For Roth IRAs, individual, head of household, and married filing separately tax filers earning less than $150,000 in adjusted gross income can contribute up to the maximum. You can contribute a reduced amount if you earn between $150,000 to $165,000. You cannot contribute to a Roth IRA if you earn more than $165,000. If you’re married and filing jointly or a surviving spouse, you can contribute the maximum if you earn less than $236,000 and a reduced amount if you earn between $236,000 and $246,000. You cannot contribute to a Roth IRA if you have a combined adjusted gross income of more than $246,000.2
With 401(k)s, you can defer up to the maximum to a 401(k) no matter how much you earn. However, if you earn more than $350,000 for 2025, your employer’s matching funds may be more limited.
Traditional IRAs have income limits regarding how much of your contribution is tax-deductible, and they are dependent on whether you were also covered by a retirement plan at work. For individual taxpayers covered by a plan at work, tax benefits start to phase out at income above $79,000, and those earning $89,000 or more will not be able to take any tax deduction for contributions.2
For married couples filing jointly, this traditional IRA phase-out range is income above $126,000 but below $146,000 if the contributing spouse has access to a workplace retirement plan. The range shifts to income above $236,000 but less than $246,000 for an IRA contributor who doesn’t have access to a workplace retirement but is married to and filing jointly with someone who does.
Are Retirement Savings Taxed?
Your retirement savings are not taxed during the time they are in your account. They grow tax-deferred. Instead, you’ll pay income tax either when you contribute or when you withdraw the funds, depending on the type of account.
So, if you invested your retirement savings in assets that have increased in value, you will not have reportable income or pay taxes on those earnings each year, but you may have to pay taxes on them when you withdraw the funds.
How RMDs Are Taxed
Retirement accounts cannot benefit indefinitely from tax-deferral. A required minimum distribution, or RMD, is the minimum amount you must withdraw from your retirement account each year starting at age 73. Participants in a workplace retirement plan can delay RMDs until retirement, unless a 5% owner of the sponsoring business. These distributions are taxed as ordinary income.6
RMDs are required for tax-deferred accounts like traditional 401(k)s and IRAs. Alternately, Roth IRAs and Roth 401(k) accounts don’t require RMDs while the account holder is still alive, but beneficiaries are required to take them once the account holder has passed.7
You’ll pay taxes on RMDs along with other sources of income according to the rate of your tax bracket in the year of the distribution. Many investors have a lower tax bracket during their retirement years, so they’ll pay less in taxes than they would have during their working years. That’s the significant advantage of a tax-deferred retirement plan.
If you don’t take your RMD, you’ll be taxed 25% on the amount you did not withdraw (10% if the RMD is taken within two years).7
The Bottom Line
Understanding the tax benefits of retirement plan contributions and tax impact of distributions will help guide you to the best retirement account for your situation. Consider consulting a professional financial advisor for guidance on which type of account may suit your personal situation.
1 IRS.gov, “401(k) Plan Overview” https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-overview
2 IRS.gov, “401(k) Limit Increases to $23,500 for 2025, IRA Limit Remains $7,000” https://www.irs.gov/newsroom/401k-limit-increases-to-23500-for-2025-ira-limit-remains-7000
3 IRS.gov, “Retirement Plan Topics – IRA Contribution Limits” https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits
4 IRS.gov, “401(k) Plan Qualification Requirements” https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-qualification-requirements
5 IRS.gov, “401(k) Plans – Deferrals and Matching When Compensation Exceeds the Annual Limit” https://www.irs.gov/retirement-plans/401k-plans-deferrals-and-matching-when-compensation-exceeds-the-annual-limit
6 IRS.gov, “Retirement Topics – Required Minimum Distributions (RMDs)” https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds
7 IRS.gov, “Retirement Plan and IRA Required Minimum Distributions FAQs” https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions
Beth Schanou is a non-registered affiliate of Cetera Advisor Networks, LLC.
This information is not intended to provide specific legal, tax, or other professional advice. For a comprehensive review of your personal situation, always consult with a tax or legal advisor.
Converting from a traditional IRA to a Roth IRA is a taxable event.
A Roth IRA offers tax free withdrawals on taxable contributions. To qualify for the tax-free and penalty free withdrawal or earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59 ½ or due to death, disability, or a first-time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes.
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