You may have heard the term “pre-tax” 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 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 will assess taxes on ALL of your salary.
So let’s also assume that your salary is $50,000. From that, you choose to contribute 10% per paycheck to your 401k. That means you contribute $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. This is because your 401k contribution is taken from your paycheck pre-tax. (Note: Pre-tax does not mean you avoid any FICA taxes. You may owe Social Security and Medicare tax, for example. FICA taxes are based on gross pay.)