What are pre-tax deductions and contributions?
Pre-tax deductions are funds employers take from an employee’s gross pay before withholding any taxes. These deductions can reduce an employee’s taxable income, and often take the form of retirement contributions, insurance premiums, and other perks offered in benefits packages.
Employee benefits can help companies attract and retain top talent. And many of them are pre-tax deductible.
Contributions to certain benefits schemes ease tax burdens for employees and employers alike. That, in turn, means pre-tax deductions can help boost take-home pay, control costs, and allow companies to offer premier benefits packages without breaking the bank.
This guide will help you make the most of pre-tax deductions and contributions.
What are pre-tax deductions and pre-tax contributions?
Pre-tax deductions are funds employers take from an employee’s gross pay before withholding any taxes. These deductions can reduce an employee’s taxable income, meaning they’d owe less taxes. They can also lower an employer’s contribution toward the Federal Unemployment Tax Act (FUTA), state unemployment insurance (SUI), and the Federal Insurance Contributions Act (FICA).
Employees typically choose how much to contribute toward these deductions, while businesses can choose to make contributions on the employee’s behalf. Employers withhold deducted funds from an employee’s paycheck and add them to designated accounts.
Employers often include pre-tax deductions like retirement contributions and insurance premiums in benefits packages. A pre-tax contribution typically refers to a deduction in the form of employee payments to a retirement plan like a 401(k).
Types of pre-tax deductions and contributions
Learn about the most common pre-tax deductions below.
Health insurance premiums
When employees join certain employer-sponsored group health insurance plans, they typically pay their premiums from their pre-tax gross salary. Contributions to health plans (including vision and dental insurance) and Health Savings Accounts (HSAs) often take the form of pre-tax deductions. For instance, in 2024, taxpayers can contribute up to $4,150 for self-only HSA coverage without paying federal income taxes, and families can contribute up to $8,300.
However, keep in mind that whenever employers pay a portion of their workforce’s health plans, they typically deduct costs from business taxes. In this case, the funds don’t count as pre-tax deductions.
Retirement funds
Employee contributions to traditional retirement plans like 401(k)s or 403(b)s count as pre-tax deductions and can lower taxable incomes. The 2024 contribution limit for 401(k)s is $23,000.
Contributions to Roth IRAs, however, are post-tax deductions, meaning they’re taken from an employee’s net pay after taxes. These deductions won’t affect an employee’s taxable income.
Flexible Spending Accounts (FSAs)
Employees can contribute pre-tax dollars to FSAs, which can cover out-of-pocket medical expenses like deductibles, copays, and medical devices, and prescription medication for both the taxpayer and their dependents. The maximum contribution limit for FSAs in 2024 is $3,200 for individuals and $6,400 for couples.
Commuter benefits
Employees can also make pre-tax deductions towards daily commuting expenses—like bus fares, parking costs, and subway passes. Commuter programs are considered fringe benefits by the IRS, which lists a 2024 pre-tax limit of $315 a month for vehicle transport and transit passes and an additional $315 a month for parking.
At the local level, many major US cities—including New York City, San Francisco, and DC—mandate that employers over a specified size offer commuter benefits.
Life insurance
Group life insurance premiums count as pre-tax deductions for federal income taxes, FUTA, and FICA. But keep in mind that coverage exceeding $50,000 is no longer pre-tax deductible.
Complying with pre-tax deductions
Employers offering pre-tax deductible benefits need to be mindful of compliance issues. Before including pre-tax deductions in your employee package, consider the following.
- Understand eligibility criteria: Pre-tax contribution limits can change annually for different benefits, and employees need to know when they can and can’t use earmarked funds (e.g., you need to be enrolled in a high-deductible health plan to contribute to an HSA). Check federal, state, and local limitations to ensure employees don’t over-contribute.
- Maintain documentation and records: Ensure every employee has access to every benefit you offer and publicize conditions for each perk in your employee handbook.
- Ensure employees report pre-tax deductions: Employees need to report pre-tax deductions as part of their W-2; distribute forms and make accurate withholdings to avoid any missed payments or miscalculations.
Pre-tax deductions implications for employers
Pre-tax deductions can ease an individual employee’s tax burden. They can also benefit employers—so long as they avoid compliance pitfalls. Here’s what businesses should bear in mind.
Payroll tax savings
When employees contribute pre-tax deductions to fringe benefits, they lower their personal taxable income as well as the total taxable income of a company’s entire payroll. This means employers owe less toward their portion of payroll tax contributions.
Impact on budgeting and financial planning by reduced costs
By lowering a company’s payroll tax burden, pre-tax deductions can help businesses accurately control costs, increase profits, and make smarter financial decisions. You can also improve headcount planning by assessing the true cost per new hire after deductions kick in, and use post-tax take-home pay data to set compensation bands that help you attract top talent while staying within budget.
Compliance with tax and benefits regulations
Pre-tax deductions can save money for employers and employees alike. But businesses can get bogged down by the administrative burden of managing every fringe benefit, withholding the right deduction amounts, and complying with contribution limits along with federal, state, and local eligibility criteria.
If you want the benefits of pre-tax deductions without the cumbersome busywork, consider using a software solution—like an HCM, PEO, or payroll provider—that can help you compliantly manage benefits and tax withholdings.
Manage employee benefits and compliance with Rippling
Rippling is an all-in-one workforce management platform that helps businesses administer top-notch benefits, monitor compliance with pre-tax deductions, and automate payroll to make the right tax withholdings for every employee.
With Rippling you can bring all your pre-tax deductible employee benefits—from medical, dental, and vision plans to FSA, HSA, and retirement contributions—into a single platform linked to employee and payroll data. You can also automatically enroll newly onboarded hires in benefits.
What’s more, Rippling has powerful integrations with 401(k) providers, including:
These API integrations read Rippling’s information for contribution amounts and update the system for deferral rate changes—relieving HR teams of the tedious manual work involved in withholding the right deductions workforce-wide.
Businesses can also use Rippling’s top-rated PEO to access big company benefits—including pre-tax deductible perks like HSAs, FSAs, and retirement plans—at affordable rates.
This blog is based on information available to Rippling as of July 8th, 2024.
Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.
