Do elective deferrals to a 401(k) plan reduce federal income tax withholding and FICA taxes?

• A. They reduce federal income tax withholding; they are subject to FICA, so FICA wages include the deferrals.
• B. They reduce both federal income tax withholding and FICA taxes.
• C. They do not affect federal income tax withholding; they reduce FICA wages only.
• D. They increase federal income tax withholding but reduce FICA.

Answer: (A)

Pre-tax 401(k) contributions reduce the wages used to compute federal income tax withholding, so withholding is lowered. At the same time, these deferrals are still subject to FICA taxes (Social Security and Medicare), meaning the FICA tax base includes the deferral amount. So you see less federal income tax withheld now, but FICA taxes continue to apply to the full earnings including the deferral. That’s why the best choice states: they reduce federal income tax withholding; they are subject to FICA, so FICA wages include the deferrals.