What are Pre-Tax Deductions
Voluntary contributions or deductions from your pay can affect your net take-home pay. These voluntary contributions can reduce your current tax rate and potentially increase your net take-home pay. These contributions are included in your employer's cafeteria plan, and participation is optional. A cafeteria plan can be described as going into a high school cafeteria, and you get to select what you want to put on your tray. You may consume some of the items you choose, and other options declined. Let's review how pre-tax contributions are deducted from your gross pay.
You can use Flexible Accounts for daycare and medical expenses. A Flexible Spending Account (FSA) can be used for qualifying medical purchases throughout the year. With an FSA, you can pay for eyeglasses, dentures, over-the-counter medication, menstrual supplies, and more using an FSA card. You can use the Dependent Care Account (DCA) for qualified daycare expenses. If you decide to contribute to an FSA or DCA, your contributions will be deducted from your gross pay using pre-tax dollars.
See my feature in Smart Ways to Use Up Your FSA Before the Year Ends
Contributing to your retirement can help you build a secure financial future. Whether it's a 401(k), 403(b), or other qualified retirement plan contributing a portion of your income can increase your current and future wealth. If you elect retirement contributions or your employer auto enrolls you, contributions will be deducted from your gross pay. View the calculation below to see how a 10% retirement contribution rate could affect your gross income*.
See my feature in the Retirement Planning Guide
If you've elected medical, dental, vision, life insurance, or any other insurance benefits through your employer, premiums will be deducted from gross pay. Premiums for insurance benefits can become expensive, so it's essential to understand that your employer shares some of the costs. The term that relates to this is cost sharing. For example, if your employer shares 70% of the cost of your family medical premium and you pay the other 30%, the monthly breakdown could look like this:
0.30 x $1,100 = $330
Your shared cost x monthly premium = premium you pay
0.70 x $1,100 = $770
Your employer's shared cost x monthly premium = premium your employer pays
Understanding an employer's cost share is essential when negotiating your salary.
Cap Contribution Limits
There are cap or maximum contribution limits that you can make to some of these plans. For 2022 the annual maximum you can contribute to an FSA is $2,850. Dependent Care contributions vary based on your tax filing status. Rates were increased in 2021 when the American Rescue Plan Act was signed into law. Basic defined contribution plan (401(k)) contribution limits are capped for 2022 at $20,500. It's important to note that there are maximum contribution limits, but your employer has the option to choose a lower amount.
*This example calculation assumes gross pay is $30,000, a 10% retirement contribution, no state taxes, semi-monthly pay frequency, and federal filing status of single.