A traditional retirement deferral is the one common deduction that is exempt from one tax and not the other. It is why a paystub carries two different taxable-wage figures, why W-2 Box 1 is lower than Box 3, and why this is the most-missed item in payroll calculation questions.
A traditional 401(k) elective deferral is exempt from federal income tax. It is not exempt from Social Security and Medicare tax. The money is taxed for FICA in the year it is deferred.
That single asymmetry is why a paystub can carry two different taxable-wage figures, and it is the most-missed item in payroll calculation questions. Everything below is the consequence.
Most deductions behave consistently — either they come out before tax or they do not. A Section 125 cafeteria plan premium is exempt from income tax and from Social Security and Medicare. Union dues are exempt from neither.
The 401(k) deferral is the odd one out, and it forces the split.
| Deduction | Federal income tax | Social Security & Medicare |
|---|---|---|
| Section 125 health premium | Exempt | Exempt |
| Health FSA / dependent care FSA | Exempt | Exempt |
| Traditional 401(k) deferral | Exempt | NOT exempt |
| Traditional 403(b) / 457(b) deferral | Exempt | NOT exempt |
| Roth 401(k) contribution | Not exempt | Not exempt |
| Union dues, garnishments, charitable giving | Not exempt | Not exempt |
Priya is paid semi-monthly. This period she has $4,200.00 of regular salary and a $3,000.00 bonus paid with her regular wages. She has a $180.00 Section 125 medical premium and defers 6% of gross into a traditional 401(k).
| Step | How it is built | Amount |
|---|---|---|
| Gross pay | $4,200.00 salary + $3,000.00 bonus | 7,200.00 |
| Section 125 medical | Exempt from everything | 180.00 |
| 401(k) deferral | 6% × $7,200.00 | 432.00 |
| Total pre-tax deductions | $180.00 + $432.00 | 612.00 |
| Taxable wages — income tax | $7,200.00 − $612.00 | 6,588.00 |
| Taxable wages — FICA | $7,200.00 − $180.00 only | 7,020.00 |
| Social Security tax | $7,020.00 × 6.2% | 435.24 |
| Medicare tax | $7,020.00 × 1.45% | 101.79 |
| THE TWO WAGE FIGURES DIFFER BY THE DEFERRAL | 432.00 | |
Run Social Security off the income-tax wages of $6,588.00 instead and you get $408.46 — $26.78 short. Medicare comes out at $95.53 instead of $101.79, a further $6.26 short. The employer's matching side is wrong by the same amounts again, so a single misplaced deduction produces four wrong figures.
The rule is not arbitrary. Social Security benefits are earned on the basis of Social Security wages. If deferring into a 401(k) reduced those wages, every dollar an employee saved for retirement would quietly reduce the Social Security credit they were building for that same retirement.
So the deferral is taxed for FICA when it goes in, and it is taxed for income tax when it comes out in retirement. Each dollar is taxed once by each system, just at different moments. Once that lands, the rule stops being something to memorise.
The split does not disappear at year end — it is printed on the form. On a W-2 for an employee with a traditional 401(k), Box 1 will be lower than Boxes 3 and 5, and the difference is the deferral.
| Box | What it holds | Deferral removed? |
|---|---|---|
| 1 | Wages, tips, other compensation | Yes |
| 3 | Social Security wages | No |
| 5 | Medicare wages and tips | No |
| 12 | Code D — the elective deferral amount | Reported here |
An employee ringing payroll to ask why Box 1 and Box 3 do not match is usually looking at exactly this, and “your 401(k) came out of one and not the other” is the whole answer.
A Roth 401(k) contribution is taxed for income tax and for FICA on the way in, and comes out untaxed later. On a paystub it behaves like a post-tax deduction: it reduces net pay and no taxable wage figure at all. It still reports in Box 12, under code AA rather than D.
The elective deferral limit applies per employee per calendar year across all plans, not per employer. Someone who changes jobs mid-year can exceed it without either payroll department noticing. And when a question tells you the plan's definition of eligible compensation — before other deductions, after them, excluding bonuses — use that definition rather than assuming gross.
No. A traditional 401(k) elective deferral is exempt from federal income tax but is still subject to Social Security and Medicare tax. The deferral is taxed for FICA in the year it is deferred. This is why Box 1 of a W-2 is lower than Boxes 3 and 5 for an employee who contributes to a traditional 401(k).
The most common reason is a traditional retirement deferral. Box 1 shows wages for federal income tax, which excludes the deferral. Boxes 3 and 5 show Social Security and Medicare wages, which do not exclude it. The difference between them is usually the amount reported in Box 12 under code D.
No, and this is the distinction that matters. A Section 125 cafeteria plan premium is exempt from federal income tax and from Social Security and Medicare tax, so it reduces both wage figures. A traditional 401(k) deferral is exempt from income tax only, so it reduces one figure and not the other.
Subtract only the Section 125 amount from gross pay. On gross of $7,200.00 with a $180.00 Section 125 premium and a $432.00 traditional 401(k) deferral, income-tax wages are $6,588.00 but FICA wages are $7,020.00. Social Security is 6.2% of $7,020.00, which is $435.24, not 6.2% of $6,588.00.
As a post-tax deduction. A Roth contribution is subject to federal income tax and to Social Security and Medicare tax on the way in, so it reduces net pay without reducing any taxable wage figure. It is reported in W-2 Box 12 under code AA rather than code D.
Knowing this rule and applying it under time pressure are different things. Our practice app has a Gross-to-Net Ladder whose third scenario is this exact split — a bonus and a deferral, with separate rungs for income-tax wages and FICA wages — and a Register Error Hunt where one of the errors hiding in the payroll register is Social Security taken on the wrong wage base.
If you want to find out whether this area is actually your weak one first, the 20-question assessment is free. No card, and it scores you by content area.
The full bank is 570 questions for $69, once, with a written explanation on every question and a 30-day refund. It is drill. It does not replace PayrollOrg's own materials and does not claim to.
Take the free 20-question assessment → See the full question bank — $69 once →PUBLISHED 2026-08-08 · ESCHEAT SHEET