What are pre-tax deductions and contributions?

What are pre-tax deductions and contributions?

Post-tax deductions are amounts taken from your paycheck after taxes are withheld. Often out of sight and out of mind, pre-tax deductions and contributions leave before the direct deposit hits a bank account. Here’s what you need to know about pre-tax deductions, especially regarding health insurance.

Paychecks and pre-tax income

Anyone who’s looked at their paystub is familiar with pre-tax income. Pre-tax income, or gross pay, is a person’s income before deductions. Many pre-tax deductions and contributions are optional, employers will decide whether they would like to elect to participate. Some of the most common pre-tax deductions can include retirement contributions, health plan contributions, and income tax deductions.

Pre-tax deductions can include retirement contributions, health plan contributions, and income tax deductions.

For full-time employees with a W-2, an employer will automatically deduct pre-tax contributions, including estimated tax contributions based on an employee’s annual income and tax bracket, which could be anywhere from 10% to 37% of an employee’s pre-tax income for the 2023 tax year.

The other deductions might be elected by the employee. Depending on the structure of their health insurance and retirement policies, they might select how much they want to be contributed pre-tax each month.

Pre-tax income on a pay stub isn’t the same amount a full-time employee gets in a paycheck or direct deposit. It will vary based on their taxes and deductions.

Pre-tax health insurance deductions

Pre-tax health insurance deductions, or pre-tax medical premiums, are deductions made to an employee’s paycheck pre-tax or payroll deductions. If a company offers an employer-sponsored healthcare policy, these deductions help cover the cost of an employee’s healthcare premium.

Pre-tax health insurance deductions will vary based on the cost of an employee’s monthly healthcare premium and how much of it is covered by the employer. For example, some companies fully cover their employee’s healthcare premiums as a benefit. In that case, an employee wouldn’t see a pre-tax health insurance deduction on their pay stub (unless they were enrolled in an HSA or FSA program).

Pre-tax health insurance deductions could be any or all of the following:

• Health insurance premiums for major medical coverage

• Supplemental coverage, such as vision or dental

• Employee-elected contributions to health savings accounts (HSAs) or flexible savings accounts (FSAs)

Employees can always determine their pre-tax health insurance deductions by looking at their pay stubs. Under the “deductions” section, they should be able to see which deductions come from their gross pay.

Advantages of pre-tax health deductions and contributions

While it can be tough to see money disappear before it even hits your bank account, there are some big advantages to pre-tax health deductions and contributions.

Paying a health insurance premium pre-tax can save you up to 40% on the cost of coverage. That’s because the deduction takes place before gross pay is taxed. Depending on an employee’s tax bracket, anywhere from 10% to 37% will go towards the IRS.

Similarly, these deductions reduce an employee’s taxable income. This can potentially lower their overall tax liability and increase their take-home pay.

For some, it can also be a more effective budgeting tool. Instead of allocating a paycheck towards health insurance, the costs are already covered. This helps employees manage healthcare costs effectively, as they can use pre-tax dollars to cover these expenses rather than after-tax income.

Finally, pre-tax health deductions can also include HSAs and FSAs. FSAs allow employees to set aside pre-tax funds for medical expenses not covered by insurance, while HSAs provide a triple tax advantage—contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are also tax-free.

What are post-tax health insurance deductions?

Compared to pre-tax deductions, employees will see post-tax deductions in their bank account monthly. Here’s how they work and the benefits of these deductions and contributions.

Post-tax health insurance deductions

Someone might have post-tax health insurance deductions for the following reasons:

• The employer doesn’t offer a pre-tax health insurance deduction plan

• The employee opts out of an employer-sponsored health insurance plan

If an employee doesn’t have a healthcare spending account, like an HSA or FSA, any qualifying medical expenses, such as co-pays, prescriptions, or payments can also count as a post-tax health insurance deduction.

Additionally, individually purchased health insurance plans can also come with post-tax deductions. This includes:

• Individually purchased plans from the health insurance marketplace

• Additional or supplemental coverage, including accident or disability insurance

Advantages of post-tax health deductions and contributions

While pre-tax deductions sometimes feel like “free money” towards coverage, post-tax health deductions and contributions also have a fair share of benefits.

Individuals who file an itemized tax return may be able to deduct medical expenses from their gross income if premium payments account for more than 7.5% of their adjusted gross income (AGI).

Post-tax contributions to HSAs also have an advantage as they are not subject to the “use-it-or-lose-it” rules of an FSA, where funds must be spent within the year or will be lost.

ICHRAs: The benefits of pre-tax, with the flexibility of post-tax

Seeking cost savings solutions for employee healthcare plans? Individual coverage HRAs (ICHRA) can help save on coverage while offering flexible plans for all levels of employees.

ICHRAs are attractive because they provide more flexible and cost-effective healthcare benefits plans for teams. ICHRAs are available to companies of any size, whether they employ part-time or full-time employees.

Employers can give employees a pre-tax healthcare allowance or reimbursement to purchase the healthcare plans that best suit them. ICHRAs have the benefit of pre-tax spending but with the personalization of a post-tax health insurance policy.

Thatch makes it easy to set up an ICHRA, giving your team the healthcare that’s best suited to their needs. Simply set a budget, and your employees spend it as they see fit.