Pre-Tax Deduction Vs. Post-Tax Deduction

Your paystub reflects the deductions taken from your earnings.
i Comstock/Comstock/Getty Images

When you get paid, numerous deductions can taken out such as taxes, 401(k) payments, insurance, Flexible Spending Accounts, Heath Savings Accounts and wage garnishments, among the most common. Some of these are taken from your check pre-tax and others post-tax. Though the pre-tax deductions lower the wages upon which your taxes are calculated, they do have other implications that should be considered.

What's the Difference?

You are paid a certain wage for the work that you perform. This amount is then reduced by the deductions taken from your pay. Deductions that are pre-tax reduce your wages first. Your post-tax deductions, such as income taxes, are then calculated based on this reduced wage and are therefore lower than they would have been. In this way, your pre-tax deductions save you a little money, adding to your ongoing cash flow. Depending on your situation, this could be the way to go. The more pre-tax deductions you can take, the lower the taxes that are taken from your check and the more money in your pocket.

Retirement Implications

Your Social Security and Medicare taxes are deductions that are based on a percentage of your taxable income. The amount you pay into the Social Security fund determines the amount you receive at retirement. Since pre-tax deductions reduce your taxable income, which reduces your contribution, you are effectively borrowing against your future retirement income because your total contributions are reduced. The same is true if you pay into Railroad Retirement. If one of your pre-tax deductions is a 401(k) contribution, you can offset the damage done to the income-based retirement contributions.

Wage Garnishments and Pre-Tax Deductions

If your wages are being garnished, regardless of the reason, it is a post-tax deduction. Even if you have pre-tax deductions taken from your check, the wage garnishment is taken based on your total income before any adjustments are made except local, state and federal taxes; other wage garnishments; legally required deductions, such as mandatory retirement contributions, court-ordered child support and other legally required payments. Union dues are not considered to be legally required and are not excluded from the calculation.

So What Do You Do?

To a large extent, what you do depends on your situation. If you are young and have no adverse deductions like garnishments taken from your check, you may want to increase your pre-tax deductions to improve your cash flow and give you the opportunity to save some money. You can use the money you save on taxes to start a fund to buy your dream house or a new car. If you are older, and your income has risen over the years, you may want to decrease these pre-tax deductions to prepare for your retirement. At the higher salary level, you may offset some of the reductions in your contributions from your earlier days.

the nest