Pre-tax deductions are deductions applied to an individual’s gross income, thereby decreasing the amount of wages upon which local, state and federal taxes will be owed. In addition to income tax liabilities, pre-tax deductions also decrease a worker’s required contributions to Medicare and Social Security. One goal of making certain payments pre-tax is to provide incentive for people to plan ahead for various life events, such as retirement and medical expenses.
Common Pre-Tax Deductions
- Retirement savings
Contributions to any retirement savings such as a 401(k) plan, a Roth IRA, a 403(b) plan or a Government Thrift Savings Plan are deducted from an employee’s gross earnings prior to any taxation. Every dollar placed into one of these retirement savings plans reduces an individual’s taxable income by an equal amount. However, there are limits: the maximum employee contribution level for 2015 and 2016 is $18,000 or the maximum amount established by your employer, whichever is less. Additional contribution levels include $53,000 for 2015 and 2016 as the maximum annual contribution to all accounts or 100% of gross wages, whichever amount is the least. Finally, for employees over age 50, there is an additional allowance of $6,000 per year considered “catch-up” contributions.
- Employer matching of retirement savings
As an incentive to saving, employers may offer to match employee retirement savings dollar for dollar to a certain amount. Matching employer contributions, however, may not exceed $35,000 in 2015 and 2016. An employee does not pay taxes on employer matches to his or her retirement savings account.
- Employer high deductible health plans and health savings accounts
If your company offers the combination of a high deductible health plan along with a pre-tax health savings account, an employee may be able to save pre-tax dollars to pay for services and benefits that a high deductible health plan fails to cover. If your business doesn’t offer this option to employees as a group, they can still arrange for personal health savings account although it will be funded with after-tax dollars. Encourage employees to speak to your company’s human resources department for more information.
- Flexible Savings Accounts
Flexible Savings Accounts or FSAs, if your company decides to offer them, can vary as to availability and the maximum amount of annual contributions. Typically, they are used for IRS-approved medical care, procedures or supplies, or adult-care or childcare expenses. Eligible expenses should be made available in your company’s benefits manual or through your HR department.
- Group Insurance Plans
Group health insurance plans—including medical care, dental care, vision benefits, life insurance, and short and long-term disability insurance—deduct an employee’s share of the premiums out of his pre-tax wages.
Other effects of payment or savings from pre-tax dollars
For every dollar contributed to a retirement account, flexible spending account or insurance plan, an employee’s taxable income is decreased accordingly. This decrease applies not only to federal income tax, but to Medicare and Social Security deductions as well. Finally, for the majority of states with state income tax, their assessment of an employee’s income begins with the employee’s Adjusted Gross Income (AGI) or the amount of wages after deduction of these pre-tax costs and contributions.
Rules and limits change annually
The rules, regulations, allowable maximums and limits to such programs can change annually. Processing an individual’s taxes correctly is impossible without the latest information.
To boost employees’ knowledge of available programs, as well as implement a cohesive program, contact Paycor for HR and payroll solutions. Our applications can simplify your processes and allow your employees easy access to view their compensation history and pre-tax funding dollars.
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