Pre-tax and post-tax deductions: which ones lower your tax
A deduction taken before tax reduces the income that tax is calculated on. The same dollar taken after tax does not. That is the whole mechanism, and the difference is your combined marginal rate, federal plus state plus FICA where applicable.
The categories
| Type | Effect | Examples |
|---|---|---|
| Pre-tax, income and FICA | Reduces taxable wages and FICA base | Traditional 401(k) deferrals, HSA contributions, some commuter benefits |
| Pre-tax, income only | Reduces income tax, not FICA | Section 125 health, dental and vision premiums, FSA |
| Post-tax | No effect on taxable wages | Roth 401(k), union dues, garnishments, group life above the limit |
The second row matters. Health premiums reduce your income tax but not your Social Security base, which holds down your eventual benefit slightly. That is usually the right trade because the income tax saved is bigger than the benefit lost, but the direction is worth knowing.
What to check before electing anything
- Vesting. A match that vests over four years is not yours if you leave in year two.
- Eligibility and use-by rules. An FSA is generally use it or lose it, with a small carryover, so it suits predictable costs and not guesses.
- Portability. A deduction on payroll is not a benefit you can take with you when you leave.
- Fees. A workplace annuity or life product sold through payroll can be more expensive than the same cover bought directly.
The order that usually works
Free employer match first, because it is an instant return with no risk. HSA next where you have a high-deductible plan, since it is the only account that is pre-tax going in, tax-free growing and tax-free out for medical costs. Then health premiums, then dependant care if you use it. Everything else after those.
Roth or traditional
Traditional defers tax to withdrawal. Roth pays it now and takes it out free. If your marginal rate now is lower than you expect later, Roth wins; if it is higher, traditional wins. In a low-income year, a Roth contribution is often the better use of the same dollar.