You may have heard the term “pre-tax” used in the context of your company sponsored retirement plan (401k or similar). What you may not realize is just how beneficial, and rare, that term really is.
Let’s Assume That Your Employer Offers a Retirement Savings Plan Like a 401k.
These types of tax-favored retirement plans allow participants to contribute some of their salary to their 401k account before taxes are assessed. If you don’t contribute anything to your 401k your friends at the IRS would be assessing taxes on ALL of your salary.
So let’s also assume for this illustration that your salary is $50,000 and that you have elected to contribute 10% of your paycheck to your 401k. That means you are contributing $5,000 (10% of $50,000) into your 401k. To your benefit, the IRS is now only able to tax you on $45,000 NOT your $50,000 salary because your 401k contribution is taken from your paycheck pre-tax. (Note: Pre-tax does not mean you avoid any FICA taxes, e.g. Social Security and Medicare tax, you may owe. FICA taxes are based on gross pay.)