Process

• The process for deducting contributions to your 401k is normally handled by your employer. 401k contributions are made from your paycheck, prior to taxes being deducted. The money is then deposited into your retirement account. From there, you choose the investments you would like to invest in.
  
  

Significance

• The significance of pretax contributions is that the contributions are made right from your paycheck. With other retirement accounts, like IRAs, you deduct the contributions on your tax return. However, the initial contribution is often made with after-tax dollars.
  
  

Benefit

• The benefit of tax-deductible contributions is that more money is being deferred to investing for your retirement. This deferred income is income that would have otherwise gone to paying taxes. Because taxes are deferred, you earn more interest on your retirement savings.
  
  

Disadvantage

• The disadvantage to tax-deductible contributions to your 401k is that you are taxed on withdrawals. During retirement, all of your withdrawals are taxed at ordinary income tax rates. This may leave you paying more money in income taxes due to the fact that accumulations were tax deferred during your working years.
  
  

Considerations

• An alternative to a 401k plan is a Roth IRA. A Roth does not allow pretax contributions. Instead, after-tax contributions are made to the account and withdrawals are tax-free. Alternatively, if your employer offers a Roth 401k, you could opt to make contributions to this type of account. Roth 401k accounts accept after-tax contributions and distributions like Roth IRAs.