04 Mar Pre-Tax vs. Post-Tax Benefits: How a Section 125 Plan Saves You Money
Section 125 Plan Saves You Money
When it comes to employee benefits, understanding the difference between pre-tax and post-tax benefits can make a significant impact on your paycheck and overall financial health. A Section 125 Plan, also known as a cafeteria plan, allows employees to take advantage of pre-tax deductions, reducing their taxable income and increasing take-home pay. But how exactly does this work? Let’s break it down in simple terms.
What Are Pre-Tax Benefits?
Pre-tax benefits are deductions taken from your paycheck before federal, state, and FICA (Social Security and Medicare) taxes are applied. Because these benefits are deducted pre-tax, they lower your overall taxable income, reducing the amount of taxes you owe. Common pre-tax benefits under a Section 125 Plan include:
- Health Insurance Premiums
- Dental & Vision Insurance
- Health Savings Accounts (HSAs) & Flexible Spending Accounts (FSAs)
- Dependent Care Assistance Programs (DCAPs)
Example of Pre-Tax Savings:
Let’s say your salary is $50,000 per year, and you contribute $3,000 toward your health insurance premiums through a Section 125 Plan. Since this amount is deducted pre-tax, your taxable income is reduced to $47,000, meaning you pay less in taxes and take home more money.
What Are Post-Tax Benefits?
Post-tax benefits are deductions taken after taxes have already been applied to your paycheck. These benefits do not lower your taxable income, but they may provide tax-free payouts later. Common post-tax benefits include:
- Life Insurance (for amounts above $50,000 in coverage)
- Roth 401(k) Contributions
- Disability Insurance
- Certain Supplemental Insurance Plans
Example of Post-Tax Costs:
If your salary is $50,000 and you have $2,000 in post-tax deductions, your taxable income remains at $50,000, and your taxes will be calculated based on that amount.
How Does a Section 125 Plan Save You Money?
The primary advantage of a Section 125 Plan is that it allows employees to pay for eligible benefits using pre-tax dollars, leading to:
- Lower Taxable Income: Since pre-tax deductions are excluded from taxable income, employees pay less in income and FICA taxes.
- Higher Take-Home Pay: By reducing taxable wages, employees keep more of their earnings.
- Employer Savings: Employers also benefit by saving on payroll taxes, such as FICA and unemployment taxes.
Comparison Table: Pre-Tax vs. Post-Tax Benefits
Feature | Pre-Tax Benefits | Post-Tax Benefits |
Taxable Income Impact | Lowers taxable income | No effect on taxable income |
Immediate Tax Savings | Yes | No |
Future Tax-Free Withdrawals | No | Sometimes (e.g., Roth 401(k)) |
Common Benefits | Health insurance, HSAs, FSAs | Life insurance, Roth 401(k) |
Why Employers Should Offer a Section 125 Plan
A Section 125 Plan benefits both employees and employers. Employees enjoy tax savings and increased take-home pay, while employers save on payroll taxes. Additionally, offering a cafeteria plan can improve employee satisfaction and retention by providing valuable benefits at a lower cost.
Get Started with a Section 125 Plan Today
If you’re an employer looking to provide tax-advantaged benefits to your workforce, or an employee who wants to maximize take-home pay, The Policy Shop can help. Contact us today to learn more about implementing a Section 125 Plan that works for you!