jenk

(I did the initial workup of this for a comment elsewhere, but thought it worth having around. So.)

The money in a 401(k) or 403(b) is pre-tax. What does this mean?

Example: An employee in the 25% marginal income tax bracket*, tho not maxing out the flat payroll taxes**. If she wants to put the last $100*** she earned to paying off a credit card, it works out like:

Earned	Minus income tax	Minus payroll taxes	Payment
$100	- $25	-$7.65	= $67.35

But if she puts that last $100 she earned into a 403(b) or 401(k), then there's an extra $25 available:

Earned	Minus income tax	Minus payroll taxes	401(k) contribution
$100	- $0	-$7.65	= $92.35

Now, you may be thinking, "I don't want to reduce my paycheck by $92.35". Well, you wouldn't be. Remember that you normally only get the after-tax $67.35. Putting $92.35 into your 401(k) only reduces your after-tax paycheck by $67.35. To put it another way, you aren't going to have that $25 in hand anyway. You can send it to the Treasury, or to your 401(k). Which would you prefer?

Yet another way to look at it: Taking the $67.35 out of our example's paycheck and putting into her 401(k) gets an immediate $25 return. Yes, taxes will probably have to be paid when the money is withdrawn, but in the meantime the investment proceeds grow tax-free - which means you get more capital to invest. Yay, compound interest.

Where would one not want to use a 401(k)?

If all the investment options suck. If the choices are employer stock, an annuity, and a money-market fund, I'd pass.
If you need the after-tax income more than the tax savings. You should not plan on using your 401(k) money until you're over 59.5 years old****, so make sure you have other savings for more immediate emergencies.

Suppose our example person spent that last $100 on something subject to sales tax? Then it would work out as:

Earned	Minus income tax	Minus payroll taxes	Minus sales tax	Spending money
$100	- $25	-$7.65	- $5.50	= $61.85

Ain't math fun?

*25% is not only a real marginal tax rate, but it's relatively easy to do math with. You can see your marginal tax rate here.

**Payroll taxes - social security and medicare taxes are flat rates. Social security is on the first $X of income per year; 1/2 is paid by the employer and 1/2 by the employee. Medicare is a flat % on everything. This is why W-2s tend to have "Federal Taxable Wages", "Social Security Taxable Wages", and "Medicare Taxable Wages".
This example assumes employee who is not maxing out Social Security.

***Yes, I know your paycheck shows the same income tax taken out each month. This is because payroll services calculate your total tax and spread it out over the year so you don't start off paying 10% in income tax in January, 15% some months later, and so on. However, the highest tax bracket you fall in (aka marginal tax rate) is the tax rate at which your 401(k) is discounted, so this is a valid example...unless you put enough money into your 401(k) to drop you down to the next marginal tax rate, which, wow, sounds like a cool test case for ze payroll software ;)

****Pretty much...hardship exemptions exist but are hard to get and loans reduce your return. You can also retire early and take "substantially equal periodic payments" based on your life expectancy (thoughtfully provided by the IRS) and take it out each year. But if you have the money to do that, you also probably have the money to hire