Your Paycheck – Before-Tax Deductions

Why this should interest you?

You could pay lower taxes!!

Before-tax deductions are subtractions from your gross income before taxes are computed, therefore lowering your taxable income. An example of a pre-tax deduction is a contribution to a 401(k) retirement plan or payment for benefits such as health insurance.

A simple illustration (assume no other tax except federal withholding, no social security medicare, state, local, etc)

Joe, a single male, is a video game tester and has a gross income of $2,000/month, this also happens to be his taxable income. In this instance Joe has $238.33* withheld from his pay check each month for federal taxes, leaving him with a net income of $1,761.67 ($2,000-238.33).

Next month, Joe’s boss announces the company will begin offering the option to contribute to a 401(k) retirement plan. Joe decides to take part and contribute $100 a month. His gross income is still $2,000/month but his taxable income has now decreased to $1,900 ($2,000 – $100). Contributing to the retirement plan lowers Joe’s federal tax withholding to $223.33* a month, a $15 reduction from the previous pay period. Joe’s net income is now $1,676.67. It is lower than last month, but remember, he keeps the $100 contributed to his 401(k), and when you add the contribution to net income, total income equals $1,776.67 which is $15 higher than last month.

As you can see pre-tax deductions are generally good, as they allow you to contribute or spend money before it is taxed, saving you money.

Other examples of pre-tax deductions

  • Retirement programs in addition to 401(k) such as a 403(b)
  • Employer benefits such as medical insurance, dental insurance, etc
  • Flexible spending accounts
  • Healthcare spending accounts

For more information specific to your pre-tax deductions contact your employers HR department.

*Federal tax withholding computed using the federal tax withholding table in the post Federal Tax Withholding. Remember to convert monthly gross income to an annual amount 1st.

1 thought on “Your Paycheck – Before-Tax Deductions

  1. Pingback: It’s a Retirement Party! | I'm Bad at Spending Money

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