Pre-Tax Dollars: What Does It Mean and How Can I Use It?

Income and Investments Female hands counting and holding US dollars

Pre-tax, after-tax, who cares? Everything gets taxed, right? Well, not always. There are some employee benefits that are never taxed, and you can also benefit from deferring taxes for many years.

Benefits That Aren’t Taxed: If an employer pays the cost of medical or dental insurance for its employees and their dependents, those payments are not taxed to the employee for either income or payroll taxes. Other non-taxable benefits you can receive from your employer include employee discounts, health club benefits, meals on the premises, some child care benefits, and employee parking. Voluntary contributions to Section 125 plans for medical costs, child care and the like are also never taxed if the funds are used for those expenses.

Funds That Are Taxed Later: When you make contributions to your employer’s 401(k) plan, your contributions aren’t currently taxed. That means the money that would ordinarily have gone to income taxes can be invested to grow in your 401(k) plan. Sure, you’ll have to pay tax on that money down the road when you draw it out, but meanwhile, over time it will go up in value, and you’ll get to keep the earnings that remain after paying those taxes. And it is likely that your taxable income will be less in retirement, so you’ll be in a lower tax bracket than you are now. (Note that contributions to 401(k) plans are currently taxed for payroll taxes such as social security, Medicare and the like).

Earnings That Are Never Taxed: If you make contributions to a Roth 401(k) plan, you’ll still have to pay tax now on the funds you put in. The big tax advantage is that the growth on those funds is never taxed in the future so you can draw those funds out tax-free in retirement. That’s a big advantage for younger savers who have years and years to save for retirement and lots of tax-free growth on those savings ahead of them. For older savers, the current tax savings offered by a tax-deferred 401(k) is a better bet.

What Tax-Deferred Savings Mean for You: Let’s say that 25% of your wages are withheld for federal and state income taxes, and that you determine you can spare $100 from your net paycheck to save for the future. You could just take $100 from your net pay and set it aside in an investment, but here’s a better idea: If you contribute that $100 to a pre-tax plan such as your 401(k) plan at work, because that $100 isn’t currently taxed, you are saving $25 in current income taxes.

Still have questions? Don’t worry about knowing these tax rules. TurboTax will ask you simple questions and give you the tax deductions and credits your eligible for based on your answers. If you have questions, you can connect live via one-way video to a TurboTax Live CPA or Enrolled Agent to get your tax questions answered. A TurboTax Live CPA or Enrolled Agent can also review, sign, and file your tax return.

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