What Are the Differences Between Pre-Taxed & Non Pre-Taxed Payroll Deductions?

Pre-tax and after-tax deductions affect your take-home pay in different ways.

Pre-tax and after-tax deductions affect your take-home pay in different ways.

If you’re fortunate enough to have an employer who offers several types of benefits, you’ll want to know how the treatment of these benefits affects your paycheck. Aside from the normal cost associated with benefits you elect to receive, there’s a tax consequence or benefit associated with each type of deduction. Deductions from pay are categorized as pre-tax or after-tax deductions. Once you discover how each type of deduction affects your take-home pay, you’ll be able to decide which benefits are best for you to enroll in, and which benefits are best to leave on the table.

Definition of Pre-Tax and After-Tax Deductions

In a nutshell, pre-tax deductions are amounts you elect to have deducted from your pay before taxes are calculated. This means you won’t be taxed on the income used to pay for the deductions, but you’ll still receive the benefit of the items you elect to receive. Pre-tax deductions offer a way to save money on benefits you’d normally like to have as an employee. After-tax deductions are the opposite: Your taxes are calculated on your earnings and subtracted from your gross pay. Whatever’s left after taxes is used to pay for your elected deductions. After-tax deductions might not offer you the best savings, but you will have convenient access to employer plans that you may not be able to obtain elsewhere.

Common Pre-Tax Deductions

Common pre-tax deductions include contributions you make to a 401(k) retirement plan, elective health insurance premiums and certain other benefits, like flexible spending account and health savings account contributions. Funds you place in a flexible spending account may be used for several types of expenses, depending on the benefits your employer offers through the plan. Examples include child care expenses, educational assistance, adoption assistance and employee discount plans.

Common After-Tax Deductions

Some benefits offered by your employer are not eligible for pre-tax treatment. These include Roth IRA contributions, employer stock purchase plans and supplemental health and life insurances, like Aflac. If you participate in a union or employer-sponsored charitable cause, your union dues and donations generally also fall in the after-tax deductions category.

Strategies and Implications

You can strategize your use of pre-tax and after-tax deductions to maximize your personal goals in several ways. For example, by increasing your pre-tax deductions to a 401(k) retirement plan before the end of the year, you’re reducing your taxable income and increasing your retirement savings at the same time, which is generally a great idea. However, if you’re planning on applying for a loan that is dependent on your income, reducing your taxable income isn’t a good plan. In this scenario, you can still maximize your retirement savings by contributing to a Roth IRA instead. Contributions to this type of plan are made with after-tax dollars and don’t reduce your taxable income. Another consideration concerns IRS tax credits. Many IRS credits are dependent on lower taxable income limits. If you're on the edge of these limits, you'll want to keep your taxable income low. When planning for pre-tax and after-tax deductions, you'll need to decide if lower taxable income or higher taxable income is more important to you.

About the Author

With a background in taxation and financial consulting, Alia Nikolakopulos has over a decade of experience resolving tax and finance issues. She is an IRS Enrolled Agent and has been a writer for these topics since 2010. Nikolakopulos is pursuing Bachelor of Science in accounting at the Metropolitan State University of Denver.

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