Pre-tax Deductions

What are Pre-tax Deductions?

Pre-tax deductions are subtracted from employees’ gross salaries before taxes are calculated, reducing their taxable income and increasing their take-home salary.

Here’s a list of common pre-tax deductions in the US:

• 401(k) Contributions: Employee contributions to retirement plans such as 401(k) plans.
• Health insurance premiums: Premiums for employer-sponsored health plans.
• Flexible spending accounts (FSA): Contributions to FSAs for health care.
• Health savings accounts (HSA): Contributions to individual HSA plans.
• Commuter benefits: Contributions for public transportation or parking expenses.
• Group life insurance premiums: Premiums for group life insurance with a coverage limit of $50,000.
• Short-term and Long-term Disability Insurance: Premiums for employer-sponsored disability insurance plans.
• Cafeteria plans: Contributions to benefits under cafeteria plans.
• Adoption assistance programs: Contributions to employer-sponsored adoption assistance plans.

Pre-tax deductions offer several benefits to employees, like:

• Increases employees’ take-home pay by reducing the taxable income.
• Assists in retirement savings by contributing to plans like 401(k).
• Saves money for medical and commuting expenses.

Employers also benefit from this as it lowers the tax paid for employees’ compensation.

Let’s consider an example to understand the workings of pre-tax deductions better.

Suppose Karen earns $5,000 per month before taxes and decides to contribute $500 to her 401(k) retirement plan each month as a pre-tax deduction.

Karen’s gross income = $5000 per month

401(k) contribution = $500

Taxable income = $4500 ($5000-$500)

Then, Karen pays taxes for $ 4500 instead of $5000.

Suppose a federal tax of 20% is levied on her income.

• Without pre-tax deductions, Karen’s taxes on $5000 would be $1000 ($5000*20%).
• With a pre-tax deduction, Karen’s taxes on $4500 would be $900 ($4500*20%).

Thus, Karen saves $100 a month with her retirement contributions.

Understanding pre-tax deductions helps employees maximize their take-home pay, save for the future, and reduce their tax burden.