How a 401k and a Roth IRA are actually taxed
The mechanics of pay now versus pay later, with real dollar examples at four income levels for tax year 2026.
- 1Contribution
Deducted from gross pay. Reduces W-2 Box 1 wages and current year taxable income.
- 2Growth
Tax deferred. No annual taxes on dividends, interest, or capital gains while inside the account.
- 3Withdrawal
Taxed as ordinary income at the rate that applies in retirement. Penalty before 59.5 with limited exceptions.
- 1Contribution
Made from after tax dollars. No deduction. Income limits gate eligibility (phaseout in 2026).
- 2Growth
Tax free, permanently. No annual taxes and no taxes on later qualified withdrawals.
- 3Withdrawal
Contributions any time, tax free. Earnings tax free after 5 years and 59.5. No RMDs in your lifetime.
What contributions actually cost at four income levels
Federal tax only, single filer, 2026 brackets, $7,500 contribution example.
| Taxable income | Marginal bracket | Pre tax 401k saves today | Roth IRA cost out of pocket |
|---|---|---|---|
| $50,000 | 12% | $900 | $7,500 |
| $75,000 | 22% | $1,650 | $7,500 |
| $100,000 | 22% | $1,650 | $7,500 |
| $150,000 | 24% | $1,800 | $7,500 |
Pre tax savings reflect a $7,500 contribution multiplied by the marginal bracket, not the full 401k limit. Effective rates differ from marginal rates. Use EffectiveTaxRateCalculator.com for a personalised effective rate.
When each option wins
Pre tax 401k wins when...
- Your current bracket is higher than your expected retirement bracket.
- You plan to retire to a no income tax state (geographic arbitrage).
- You expect lower income in retirement due to downsizing or part time work.
- Reducing current taxable income unlocks credits or deductions otherwise phased out.
Roth IRA wins when...
- Your current bracket is lower than your expected retirement bracket.
- You expect higher income through career growth or business success.
- You want withdrawal flexibility before 59.5 (contributions accessible any time).
- You want to leave tax free assets to heirs and avoid lifetime RMDs.
When tax brackets are identical, the math is identical
An example most calculators omit. Same starting point, 30 years, 7 percent return, 22 percent bracket today and at withdrawal.
- Cost basis$57,150 in pre tax dollars contributed
- Equivalent net$7,500 contributed
- After 30 years at 7 percentCompounded balance $57,150 grows to $435,000
- Spendable in retirementAfter tax at 22 percent: $339,300
- Cost basis$7,500 cost out of after tax dollars
- Equivalent net$5,850 retained spending power if not contributed
- After 30 years at 7 percentCompounded balance $7,500 grows to $57,000
- Spendable in retirementTax free withdrawal: $57,000
On an apples to apples basis (same after tax cost), pre tax and Roth produce the same ending after tax dollars when brackets are unchanged. The match changes that, which is why the optimal order pairs match capture with the Roth IRA.
Tax treatment questions
Is pre tax 401k or after tax Roth IRA better?+
If your tax bracket is identical now and in retirement, pre tax and Roth produce the same after tax balance, ignoring contribution limits. The right choice depends on direction of change. Roth wins if your future bracket will be higher (younger workers, expected income growth). Pre tax wins if your future bracket will be lower.
How much does a 401k contribution save in taxes today?+
Tax savings equal your marginal federal bracket times the contribution. A $24,500 contribution at the 22 percent bracket saves $5,390 in federal taxes that year. State income tax adds further savings if your state taxes wages but follows the federal pre tax exclusion.
Are Roth IRA withdrawals always tax free?+
Contributions can be withdrawn tax free at any time. Earnings are tax free only if the account has been open at least five years and you are at least 59.5, disabled, deceased, or using up to $10,000 for a first home purchase. Otherwise earnings withdrawn early are taxable and likely subject to the 10 percent penalty.
How do state taxes affect the decision?+
States that exempt retirement income (or have no income tax) reward pre tax 401k contributions made while working in a taxing state. Pay no state tax on the contribution today, then withdraw later in a state that does not tax the distribution. Roth accounts do not benefit from this geographic arbitrage because contributions are already taxed.