Pre-Tax vs. Post-Tax Dollars - Part 1
Happy Labor Day to those of you in the U.S.!
In previous posts, I have talked about pre-tax and post-tax dollars. I thought an explanation of what those are was in order. I plan to discuss pre-tax dollars today and will finish with post-tax dollars tomorrow.
Pre-tax dollars are earnings you haven’t paid taxes on. For example, yesterday, I talked about Flexible Spending Accounts and Health Savings Accounts. I said that contributions to either one would be pre-tax dollars. So, what exactly does that mean? It’s money you’re allocating from your paycheck before any income taxes are taken out. What this means is that you’ll pay less in taxes, at least at this time. Pre-tax dollars are usually related to offerings from your employer. Examples include Traditional 401(k)’s or 403(b)’s, employer sponsored health insurance, health savings accounts, flexible spending accounts, etc.
So how exactly do pre-tax dollars benefit you? Let’s say you make $2,000 per paycheck gross salary. If you didn’t have any pre-tax contributions, you’d owe taxes on all $2,000. However, you contributed $300 to your employer sponsored Traditional Retirement plan. Additionally, you paid $200 for your employer’s health insurance plan. Both are pre-tax dollar contributions. That brings your taxable income down to $1,500. You’ll now owe federal, state, and local taxes on $1,500 instead of $2,000. Sweet!
Contributions to employer sponsored retirement plans will result in owed taxes for money withdrawn in retirement. The money you withdraw are taxable when you take distributions from your retirement accounts. The government feels they’ve waited long enough to get their money so it’s time to pay them. In theory, you don’t make as much money in retirement as you did when you worked, so you pay less in taxes. Is that true? Yes, for some, no for others. If you’re still working, time will tell.