Retirement,Saving & Spending
Pre-tax deductions: Saving money on Uncle Sam's dime!
If you're one of nearly half of all Americans who think their income taxes are too high, pre-tax deductions could help.
Pre-tax deductions are taken out of your paycheck before federal and state taxes, so they lower your net income and overall tax liability. In plain English, they make your income appear smaller, which cuts the amount of tax that you pay. In some cases, they can even push you into a lower tax bracket.
Pre-tax deductions can cover a host of expenses, from retirement accounts to health insurance, and some daily commute expenses. And if you're self-employed, you might qualify for additional deductions, including 50 percent of your self-employment taxes.
Here are a few useful tips for making pre-tax deductions work for you.
Start with retirement
Bryan Bibbo, an Accredited Investment Fiduciary, says that 401(k) contributions rank among the most common pre-tax deduction for Americans. "Assume you make $1,000 a week," he says. "If you put $200 weekly into a 401(k) plan, making that pre-tax deduction means you will not pay any current taxes on it, so you're going to save on federal and state taxes."
Admittedly, you're not getting the money completely tax free: when you withdraw the money after retirement, you will need to pay taxes. Still, Bibbo says, your tax bracket in retirement is likely to be lower than it is during your working years.
In the meantime, it's a major tax break: under 2019 IRS guidelines, the maximum employee contribution to a 401(k) or similar workplace retirement plan is $19,000 if you're younger than age 50. Those 50 and older can contribute an extra $6,000 for a total of $25,000.
To your health!
Pre-tax deductions are especially helpful for healthcare. If you contribute to an employer-sponsored group insurance plan or group health insurance, your share of the premiums are deducted out of your pre-tax wages. That can include medical and dental care, vision benefits, life insurance and short- or long-term disability insurance.
Bibbo adds that health savings accounts (HSAs) are another useful pre-tax deduction. "They're among the most missed opportunities," he says. "If you put money into an HSA pre-tax and later use the funds for medical expenses, any money withdrawn actually comes out 100 percent tax free."
That can be a significant sum: in 2019, the IRS allows singles to contribute up to $3,500 and individuals with family coverage to contribute up to $7,000.
Speaking of families, if you have children, Bibbo says dependent care expenses like babysitting, after school care or summer camp could be another place where you can save. "Some employers allow you to do dependent care expenses through your W-2," says Bibbo. "If you have children under 13 and you get dependent care benefits, it's worth checking it out with your employer."
Changing your tax bracket
Pre-tax deductions can add up quickly. If you have a large family or make an effort to max out your retirement savings contributions every year, deductions could even drop you into a lower tax bracket.
For example, imagine a married couple with a combined income of $100,000 per year. At that level, they would be in the 22 percent tax bracket in 2019.
Now, assume that they chose to put $24,000 of their income toward 401(k) contributions and their family's healthcare premiums. This would drop their taxable income to $76,000, landing them in the 12 percent tax bracket. That could save them more than $10,000 at tax time.
Of course, pre-tax deductions come with a cost. As great as they are, they're still deductions, which means that they'll reduce your paycheck. But when you look at the bigger picture, it's clear that taking advantage of at least some pre-tax deductions today is a smart fiscal move. If you're worried about feeling a little squeezed, start slow, but don't forget to keep an eye on your savings!
Lynnette Khalfani-Cox, The Money Coach, is a Chase News contributor. Her work has appeared in The Wall Street Journal and CNBC, among other media outlets.