Retirement planning is an important part of a financial plan, and it starts with knowing how much to save. One way to do this is by taking advantage of 401k contributions and other pre-tax retirement accounts. But do 401k contributions reduce AGI (Adjusted Gross Income) or MAGI (Modified Adjusted Gross Income)? What effect do these contributions have on your income taxes and savings?

Lowering your Adjusted Gross Income and Modified Adjusted Gross Income is important because many limitations on credits and tax deductions are computed using these amount. Having a lower AGI and MAGI can increase those credits and deductions, thereby lowering your overall taxes. AGI and MAGI are also used to compute government benefits, so lowering these amounts increase your ability to qualify.

It's important to understand how 401k contributions can affect your MAGI and the tax benefits associated with them. We'll also discuss some other ways to lower your AGI and MAGI.

What Is AGI?

The IRS defines Adjusted Gross Income (AGI) as the total taxable income of an individual or a taxpayer for a given year, minus certain adjustments. It is used to calculate your federal tax liability and can also be used to determine eligibility for government benefits such as Medicare or Social Security. AGI has a direct effect on your taxes, so it's important to understand how different elements of your income and deductions affect it, such as 401k contributions.

It's important to note that 401k contributions are made before taxes. Because the money you contribute is not subject to federal income tax, it is not included in the W-2 amount for your income, and therefore, reduces your AGI for the year in which they were made. This is true only for traditional 401k contributions, not contributions to a ROTH account in your 401k.

To calculate AGI, you must first determine your total income for the year. This includes:

Wages, salaries, tips, commissions, bonuses
Interest and dividend income
IRA, pension, and annuity distributions
Social Security benefits
Capital Gains/Losses
Income from sole proprietorships (Schedule C)
Flow through income from K-1's (S-Corporations and Partnerships)
Rental Income/Loss

Once you have calculated this figure, you subtract certain items using Schedule 1 such as:

Contributions an IRA (Individual Retirement Account)
Health Savings Account (HSA) contributions
Alimony paid
Medical Savings Account (MSA) contributions
Self-employed contributions to a SEP, SIMPLE, or 401k plan

On exception not listed is IRA or retirement plan rollovers. These items are not used in calculating AGI for a given tax period.

What Is MAGI?

On the other hand, MAGI stands for Modified Adjusted Gross Income. This is a term used by the IRS to calculate how much of your income may be taxed and to determine eligibility for certain tax credits, deductions, and other benefits.

MAGI is basically your AGI plus adding back additional items such as:

Traditional IRA contributions
Taxable Social Security amounts
Deductions for Tuition and fees
Passive income or loss
Rental Losses

Do Traditional 401(k) Contributions Reduce MAGI?

When it comes to financial planning, the concept of MAGI can be a bit confusing. It's an important figure when it comes to determining what deductions and credits you may qualify for on your taxes.

But does contributing to a traditional 401(k) plan reduce your MAGI? The answer is yes — but only if you're participating in a pre-tax retirement plan such as a 401(k).

Contributing to either a traditional 401(k) plan can help to reduce your MAGI because the contributions are made with pre-tax dollars. That means that when you make these contributions, they are not included in your taxable income, which is used to calculate MAGI. This can be beneficial if you're looking for ways to lower your tax bill and increase the value of your retirement savings.

Do Roth 401(k) Contributions Reduce MAGI?

It's important to note that only pre-tax contributions (not Roth contributions) are excluded from your MAGI. This means that if you're making Roth 401(k) contributions, they will still be included in your MAGI calculation and will not reduce it.

Roth 401(k) contributions do not reduce MAGI because these contributions are made with after-tax dollars, meaning that they are already included in your taxable income and therefore cannot be excluded from your MAGI calculation.

Nonetheless, even though Roth 401(k) contributions don't reduce your current tax bill or lower your MAGI, there can still be some significant advantages to making them. For example, the funds in a Roth 401(k) are not taxable upon withdrawal, which means that you could potentially avoid paying taxes on the funds in retirement.

In addition, contributions to a Roth 401(k) can provide greater flexibility when it comes to taking distributions — with a traditional 401(k), you must start taking required minimum distributions at age 70½, but with a Roth 401(k), there is no such requirement. That means that if you don't need the money, you can leave it in the account to accumulate and grow tax-free.

The Impact of 401k Contributions on MAGI

401k contributions can be a great way to reduce MAGI and minimize your tax burden. It is important to remember that the amount you choose to contribute will have an impact on your MAGI, so it's wise to assess your financial situation before making any decisions.

Furthermore, if you are able to maximize your contribution limit each year while still maintaining enough liquidity in other areas of finance, then the long-term benefits of reducing MAGI with 401k contributions could be worth the additional effort.

Ultimately, 401k contributions can be an effective tool for reducing MAGI, but it is important to consider all factors before making any decisions. To find out more about reducing MAGI with 401k contributions, contact one of our financial advisors today.

Common Uses of MAGI and AGI

Many items on your tax return use AGI and MAGI. They are used to compute income limits that determine maximum contributions or can be used to give you only a partial deduction. Here are a few of the most common:

Student Loan interest deduction
Medical Expenses
IRA Contributions

FAQ

Do 401k contributions count against AGI?

401k contributions (traditional, not ROTH contributions) reduce your adjusted gross income.

Does contributing to a 401k reduce taxable income?

Yes. 401k contributions (traditional, not ROTH contributions) reduce your taxable income.

What reduces your adjusted gross income?

Contributions to qualified accounts such as a 401k, Traditional IRA, HSA, MSA and alimony paid are the most common items that reduce your AGI.

Do IRA contributions lower AGI?

Yes, traditional IRA contributions lower your adjusted gross income. ROTH contributions do not.

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Do 401k Contributions Reduce MAGI?