Increase allowances to fund 401(k)?

What are the tax ramifications for increasing your allowances and investing the extra income in your 401(k) on a before tax basis? Obviously, you will be paying less taxes; but if you invest any extra take home pay you receive in your before tax 401(k) plan will there be any tax consequences?

Drw0867,

When you use the term allowances, do you mean income tax withholding allowances?

The more allowances you claim for income tax withholding, the smaller the amount that will be withheld. This effectively gives you more take home pay.

Or if you want, you could increase your 401k contribution. This will tend to reduce your take home pay, and decrease your taxable income.

You want to have enough income tax withholding to pay your income tax.
You also want to contribute the maximum you can afford to your 401k.
Most importantly, is to have sufficient take home pay to meet the family budget requiarements.

If you use some tax prep software, try decreasing your W-2 income by $100 increments to see how that affects your tax line. And do not forget to take into account any credits for which you qualify.

You will come to a point where you can then determine how much you want withheld for income taxes.

Don't cut yourself short, your family budget should show you what you need for income.

yes, i am talking about income tax allowances.

for example, i run the w-4 calculator in quicken after completing my tax return and it recommends I change my allowances to 9 in order to reduce my refund and generate more take home. but, i still want to keep my current take home pay where it is because we are able to maintain our family budget with this amount. should i just make the change to 9 and then see how much of a take home pay increase i get, then adjust my 401(k) contributions to erase the gain? it seems that this would end up lowering my taxable income and put me back into a situation where i would receive a sizable refund again.

i'm trying to find a way to balance the two - increase contributions to 401(k) and reduce my refund so i am not giving the government a loan with money i could be making interest on for retirement.

Drw0867,

You have the right idea.

Consider increasing your 401k contribution first. This will lower your taxable income. Your take home pay will come down but by less than you may think.

Try some different scienarios in the calculator. The IRS has a withholding calculator also. You may want to try that one too: http://www.irs.gov/individuals/article/0,,id=96196,00.html

You may need to work through this process a few times to get things where you want.