A 401(k) is a retirement savings plan offered by private employers. A 403(b) is the same idea for schools, hospitals, nonprofits and some government employers. For tax purposes they work the same way, and understanding them can save you thousands of dollars a year.
The key idea: pre-tax contributions
Money you put into a traditional 401(k) or 403(b) comes out of your paycheck before income tax is figured. It is taxed later, when you withdraw it in retirement.
So every dollar you contribute lowers your taxable income by a dollar. Less taxable income means less tax, and your employer withholds less from each paycheck. You build savings and lower this year's tax bill at the same time.
Example for 2026: James is single and earns $75,000. He contributes the full $24,500 to his 401(k).
- His taxable wages drop from $75,000 to $50,500.
- After the $16,100 standard deduction, he is taxed on $34,400.
- His paycheck withholding is already figured on the lower amount, so his take-home pay drops by much less than $24,500.
He saved for retirement and cut his federal income tax at the same time. With a correct W-4, there is no surprise bill in April.
Max out retirement, or adjust withholding?
- Prioritize retirement if you can live on the take-home pay, you want the biggest tax cut this year, or your employer offers a match.
- Adjust your W-4 if a life change (marriage, a new baby, buying a home) gives you new deductions and you want that money in your paycheck now instead of in a refund.
- Do both if you can. That gives you the most take-home pay while keeping your balance due near zero.
2026 contribution limits
- Employee contribution limit: $24,500
- Catch-up, age 50 and older: an extra $8,000
- Higher catch-up, ages 60 to 63: an extra $11,250 instead of $8,000 (from the SECURE 2.0 Act)
- Total limit including employer contributions: $72,000
Traditional vs. Roth
A traditional 401(k) cuts your taxes now, and you pay tax when you withdraw. A Roth 401(k) uses after-tax dollars, so no tax break now, but qualified withdrawals in retirement are tax-free. If you expect a lower tax bracket in retirement, traditional usually wins. Early in your career, or if you expect a higher bracket later, Roth may be better. Many people split between both.
One rule that always applies: contribute at least enough to get your employer's full match. If your employer matches 50 cents per dollar up to 6% of pay and you contribute less than 6%, you are turning down part of your compensation.
General education only, not advice for your specific situation. Figures checked October 2026. Tax law changes, so confirm current figures at IRS.gov or ask us.