Offering pre-tax benefits can be an effective tool for recruiting and adding talent to your company. There are some things to consider, however, when considering pre-tax or post-tax packages, so here’s the skinny:
What are pre-tax benefits?
In a nutshell, pre-tax benefits mean that the value of the benefit is deducted from the employee’s paycheck before they’re taxed by the federal government, ultimately reducing the amount of taxable wages an employee earns and has to pay taxes on.
Post-tax benefits, in contrast, typically include more traditional benefits like Roth 401(k) contributions, disability insurance, and most health insurance plans. As the name suggests, rather than coming out of employees’ checks before taxes, post-tax deduction (also sometimes called after tax deductions) come out after taxes have already deducted.
What is the savings with pre-tax deductions?
The savings from pre-tax deductions depends entirely on how many pre-tax benefits are elected and the amount an employee decides to contribute to them.
For example, if a single filer who makes $50,000 per year contributes $1,000 each year to an HSA account and $1,000 each year to a flexible spending account, that $2,000 is deducted from their salary before taxes. This means that their taxable income is $48,000. Instead of the $4,370 that person would have to pay in taxes for making $50,000 per year, they pay $4,130 instead because of the $2,000 they’ve allotted to pre tax benefits. This changes that person’s effective tax rate from 8.74% to 8.60% which translates to $240 saved that year.
If you’re curious about the exact amount of tax savings, check out this handy tax savings calculator.
Are pre-tax benefits or post-tax benefits better?
There are pros and cons to both type of benefits. While pre-tax benefits can increase take-home pay, they have to be elected at the beginning of the plan year and can’t be changed later unless an employee experiences what’s called a mid-year qualifying event. Much the same as life events that impact health insurance, mid-year qualifying events include things like a change in legal marital status, the gain or loss of a dependent, or a change in employment status.
Post-tax benefits can be changed at will, but they don’t reduce an employee’s tax burden the way that pre-tax benefits do. Ultimately, it comes down to what you want to offer and what your employees value.
Are payroll deductions for health insurance pre-tax?
This depends on your plan. Some plans allow for medical, dental, and vision insurance to be taken out on a pre-tax basis. Contributions to a health savings account and flexible spending accounts are almost always pre-tax benefits, while things like long and short-term disability and life insurance are almost always post-tax benefits.
This article is intended only for informational purposes. It is not a substitute for legal consultation. While we attempt to keep the information covered timely and accurate, laws and regulations are subject to change.