Today I’m continuing the subject of Pre-Tax vs. Post-Tax dollars.  Yesterday, I discussed pre-tax dollars.  I will concentrate on post-tax dollars today.

Post-tax dollars are earnings that have had taxes taken out.  These taxes include federal, state, and local taxes that you see in your paycheck.  These are subtracted from your gross income to reduce your net income. 

Examples:

For example, you earn $2,000 in your paycheck as gross income.  You pay $400 or 20% in taxes.  Your net income then becomes $1,600 without any other deductions.  As you can see, this is the opposite of pre-tax dollars.  Pre-tax dollar deductions are subtracted from your gross pay first.  Then post-tax dollars are applied after the pre-tax dollars have been deducted.

So how does this all pan out in your paycheck?  Let’s go back to that $2,000 paycheck.  Yesterday, I suggested that $300 was taken out for an employer sponsored retirement plan.  I also suggested that $200 was deducted for your employer health insurance plan.  The result was that $1,500 was left as taxable income.  You’ll owe federal, state, and local taxes on that amount. 

I want to do two more examples.  Let’s say you owe 20% in federal, state, and local taxes on your $2,000 paycheck.  In my earlier example, that was $400.  But now, you’ve reduced your taxable income to $1,500.  Using the same 20%, that would reduce your paycheck an additional $300.  So, you’ve reaped a $100 tax reduction by using pre-tax deductions to reduce your taxable income.  OK, you say…  Now I’ve got a check for $1,200 instead of $1,600.  Yup, your math is correct.  But this isn’t an accurate reflection.   And be aware that the examples given are very simplistic.

Reality:

Whether or not you paid into the retirement program, you probably will would have paid for a health insurance plan.  So now, your $2,000 paycheck is $1,800.  With a 20% tax, it would cost you $360 in taxes leaving you a balance of $1,440.  And, because of the pre-tax dollars, your taxable income is less, so the 20% is unrealistic.  20% is also unrealistic at the $1,500 level.  What this means is that the two paychecks would get closer and closer to each other and not be $400 apart.

Moral of the story:

Be aware of what Pre-Tax vs. Post-Tax dollars actually mean.  It’s important for your bottom line.  You need to understand what deductions mean to your bottom line.