Which statement best describes the effect of taxes on a traditional 401(k) retirement account?

• A. Contributions are made with after-tax dollars and withdrawals are tax-free.
• B. Contributions are made with pre-tax dollars and taxes are paid upon withdrawal.
• C. Both contributions and withdrawals are tax-free.
• D. Taxes are paid both at the time of contribution and at withdrawal.

Answer: (B)

Verified step by step guidance

1. Understand the concept of a traditional 401(k) retirement account: Contributions to a traditional 401(k) are made with pre-tax dollars, meaning the amount contributed is deducted from your taxable income for the year.
2. Recognize the tax implications during the contribution phase: Since contributions are made with pre-tax dollars, you do not pay taxes on the money you contribute at the time of contribution.
3. Understand the tax implications during the withdrawal phase: Withdrawals from a traditional 401(k) are taxed as ordinary income during retirement, based on your tax bracket at the time of withdrawal.
4. Compare the options provided in the question: Analyze each statement to determine which aligns with the tax treatment of a traditional 401(k).
5. Select the correct statement: Contributions are made with pre-tax dollars and taxes are paid upon withdrawal, as this accurately describes the tax treatment of a traditional 401(k) retirement account.