How To Not Be Taxed on 401(k)
A 401(k) retirement plan is a savings plan with significant tax advantages. If you follow the IRS rules for 401(k) contributions, you can save money before you are taxed, which allows your savings to grow faster and larger as you earn interest on the money that you otherwise would have paid in taxes.
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Instructions
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Don't exceed the maximum allowable annual contribution. IRS regulations provide maximum limits on how much you can contribute to a 401(k) account each year, and if you exceed that amount, you will be taxed on the excess. There is no reason to contribute more than the maximum amount because you lose the tax savings even though your money is then locked into the retirement account.
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Be under age 70 1/2 when you contribute. You cannot create or contribute to a 401(k) plan if you are or will be 70 1/2 years old by the end of the tax year.
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Leave the money in your 401(k) until at least age 59 1/2. If you withdraw any money before then, not only will you be taxed on the money withdrawn, you will also pay a 10% penalty on the amount withdrawn. There are only a few rare exceptions for early withdrawal.
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Claim the deductions on your annual income tax return. To avoid paying taxes on the money you contribute to your 401(k), you have to specifically list your annual contributions on your tax return, and you must claim those contributions as deductions. You can and should claim the 401(k) deduction even if you don't itemize your deductions.
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Tips & Warnings
It is unavoidable that at some point you will be taxed on the money in your 401(k), but the great benefit of the account is that it defers the date when you are taxed, which means you can earn more interest and allow your account to grow. But when you reach age 59 1/2 and you begin withdrawing, you will be taxed on the withdrawals as ordinary income. Try to forget about the money you put into your 401(k), and let it grow so you can avoid any tax penalties.
Don't forget to include a deduction on your tax return for your 401(k) contributions. Even if you claim the standard deduction--meaning you don't itemize--you need to remember to claim the 401(k) deduction.
