These days, any company that's even remotely competitive offers employee benefits. A benefits package is 1,000% essential to an engaged workforce and happy employees.
When setting up your complete benefits package, you can offer two main types: pre-tax and post-tax.
Pre-tax deductions offer immediate tax savings for the employee. But any money that's put aside from their paycheck before taxes are taken out will result in a lower taxable income.
Post-tax deductions don't provide immediate tax relief for your employees. Instead, these benefits won't be taxed when they use them in the future.
Pre-tax and post-tax deductions have their pros and cons. In this article, we'll give you the ins and outs of each.
What are pre-tax benefits?
Pre-tax benefits are deductions an employer sets aside before calculating payroll taxes. With pre-tax deductions, employees pay lower taxes throughout the year because their taxable income is lower.
For example, if an employee sets aside $100 for a pre-tax 401(k) plan, they only have to report $900 of their earnings as taxable income. So, instead of paying taxes on the full $1,000, they only have to pay taxes on $900.
Pre-tax deductions reduce income tax liability in the near future for employers and their employees. But the employee sometimes owes taxes when they use the benefit they "prepaid" for. The abovementioned 401(k) plan, for instance, is taxed when the employee withdraws it in retirement.
Not all pre-tax deductions can be completely withheld from federal income tax. Social Security, federal unemployment tax, and Medicare tax still apply to adoption assistance and other child care benefits, for example.
State and local taxes may also apply to pre-tax benefits, depending on the state. It's the employer's responsibility to stay up-to-date with their state and local tax laws.
Types of Pre-Tax Benefits
For the most part, pre-tax benefits are the ones everyone's heard of. The most common include health plans, retirement plans, disability insurance, and commuter benefits.
Health Plan Contributions
Health plan contributions are the most common pre-tax deductions. When employers set aside money for employee health plan premiums, they deduct those funds from total taxable income. Then, they're paid to the health insurance provider (or savings account) directly.
Types of health plan contributions include:
- Employer-sponsored health plans — Employers provide health coverage to employees and their dependents. Common employer-sponsored health plans include group health insurance plans, dental insurance, and vision insurance. Typically, employers and employees split the cost of pre-tax premiums.
- Health savings account (HSA) — Employees spend employer-provided funds on medical expenses for themselves and their families. Employers can set up a pre-tax HSA for employees who enroll in high-deductible health plans. In 2024, annual HSA contribution limits are rising to $4,150 (self-only coverage) and $8,300 (family coverage).
- Flexible spending account (FSA) — Employees own the pre-tax funds set aside in an FSA. They can use this money to pay for dependent care expenses or qualified out-of-pocket medical expenses, like copays and prescriptions.
Pre-Tax Retirement Plan Contributions
Employers offer retirement plans so employees can save up for their golden years. Employees make pre-tax contributions to their retirement plans, which they can withdraw money from when they're older (59 1/2 for most plans).
Common retirement accounts with pre-tax payroll deductions include:
- Traditional IRAs
- Most 401(k)s
Employer contributions are also available for retirement plans. They usually match employee contributions up to a certain percentage of their salary. So if an employer matches 50% of an employee's salary, employees would get $500 for every $1,000 they contribute.
Disability Insurance Contributions
Disability insurance covers up to 60% of a worker's salary (on average) in the event that they become disabled and can't work. Employers can set aside pre-tax dollars for disability insurance, which covers the cost of premiums.
There are two types of disability insurance:
- Short-term disability insurance — Employees receive a portion of their salary if they can't work for weeks or months due to an illness or injury.
- Long-term disability insurance — Employees with disabilities for longer than 90 days receive monthly payments for a prolonged period of time, determined by the employer's policy.
Note: Employees who wind up ill or injured after enrolling in pre-tax disability insurance will owe taxes on the monthly payments they receive.
Employers offer computer benefits to support their in-office and hybrid employees' daily commute to work. They're some of the best benefits you can offer your employees — they stretch their dollar while they get to and from the office and provide alternative commuting options while reducing payroll taxes for the business.
Pre-tax benefits commuting programs cover include:
- Train, bus, and ferry passes
- Rideshare costs
- Highway tolls
- Parking fees
- Bicycle commuting expenses
- Carpooling/vanpooling expenses
With these benefits, employers can withhold up to $300 per month for employees' commuting expenses on a pre-tax basis. Employees can access this money through a benefits card, prepaid pass, or reimbursement.
What are post-tax benefits?
Post-tax benefits are payroll deductions an employer sets aside after calculating payroll taxes. They reduce an employee's net pay, not gross pay. So employees will still owe taxes on them.
When employers deduct benefits from an employee's paycheck on a post-tax basis, they (and their employees) end up paying more in income tax than they would with pre-tax benefits. That's because many pre-tax benefits are federally tax-exempt.
Some employees prefer post-tax benefits over pre-tax benefits that are tax-deferred rather than exempt. Someone who withdraws from a post-tax 401(k), for example, won't need to pay taxes on the money when they take it out. All federal and state income taxes would have already been paid.
Except for wage garnishments (which are governed by court orders and IRS regulations), post-tax contributions are voluntary payroll deductions.
Types of Post-Tax Benefits
Although they don't reduce an employee's taxable income, post-tax payroll deductions give employees more control over their total comp package. Many types of post-tax benefits give employers the opportunity to go above and beyond for their employees.
A wage garnishment is a court-ordered deduction from a worker's paycheck. Child support, alimony payments, and unpaid loans are common reasons for them.
Employees can't opt out of these deductions — they're compulsory by order of law. So employers are responsible for calculating garnishment amounts and withholding the amount from an employee's paycheck until their debt clears.
Post-Tax Retirement Contributions
Retirement accounts with after-tax deductions are great for employees who want to save up more money but don't need the tax break that comes with pre-tax deductions.
There are three main types of post-tax retirement plans:
- Roth IRA — Employees pay income taxes on the money they contribute to a Roth IRA, but not when they withdraw it.
- After-tax 401(k) options — Employees can save up pre-tax and after-tax money in the same account. After-tax 401(k) contributions happen after pre-tax payroll deductions and employer contributions, allowing employees to save more of their paycheck toward retirement.
- Roth 401(k) — Employees contribute after payroll deductions, and the earnings grow tax-free (assuming no withdrawals before 59 1/2). The same limits that apply to a tax-deferred 401(k) apply to a Roth 401(k).
Note: Employees must specify post-tax contributions when they open their retirement plan account — these funds can't be converted from pre-tax to post-tax after they're already saved in the account.
Employees choose the coverage they want with company-sponsored life insurance policies and make payments via payroll deduction on a post-tax basis. For employers, life insurance premiums are tax-deductible as business expenses.
Group-term life insurance is the most common type of employer-sponsored life insurance. Group-term life policies are pooled into a single policy and cover all employees in the group, offering death benefits for members who pass away while they're employed.
Employers can deduct premiums paid on the first $50,000 of benefits per employee if they offer group term coverage, but these deductions will be made after tax.
A stipend is a lump-sum benefit an employer provides to account for the cost of meals, transportation, and other living expenses. They range from $50 to over $200 per month, and they help employees pay for various out-of-pocket expenses.
Types of stipends include:
- Student loan repayment
- Career and professional development
- Relocation living expenses
- Meals and transportation
- Health and wellness
- Perk stipends
While regular salary/wages for W-2 employees are taxable, a stipend isn't classified as a wage. In addition to income tax, employers neither withhold the 6.2% Social Security nor the 1.45% Medicare tax on stipends. They will, however, still need to pay state and federal income tax on those amounts.
Note: Some student loan repayment assistance is tax-exempt, so employees may be able to take advantage of pre-tax advantages.
Lifestyle Spending Accounts (LSAs)
A lifestyle spending account (LSA) is a post-tax benefit employers can offer to help employees manage healthcare, childcare, health and wellness, and education expenses (or anything else, really). They're similar to an FSA, but they offer ultimate control over how and when employees use their benefits.
Employees can access funds in an LSA up to a certain dollar amount per year, and the account balance rolls over from one benefit year to the next. When employees spend money from LSAs, they pay income tax on them.
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