The Impacts of Pre-Tax
Some of us clip coupons. Others reuse dryer sheets as dusting cloths. Some ride a bike or carpool whenever possible. However, when it comes to healthcare, most of us are willing to open up our wallets before considering ways to save. But with all the PPOs, HMOs, FSAs, HSAs, HDHPs, and millions of other acronyms explained with legal jargon and fine print, it’s no wonder a lot of us don’t know even where to start. To help clear the air, one of the best and most efficient ways to significantly save on healthcare costs and increase your spendable income is by taking advantage of pre-tax benefits.
So, I Have Pre-Tax Benefits. What Exactly Are They?
In a nutshell, pre-tax benefits allow you to pay for certain expenses through deductions taken from your pay before any taxes are taken out. Those pre-tax deductions work by discounting the amount of taxable wages you owe taxes on, so your take home pay ultimately ends up being more than if you were to pay for the same benefits on a post-tax basis.
What Kinds of Pre-Tax Benefits Are Out There?
In recent years, tax laws have been created that permit certain benefits to be paid with pre-tax money. One of the most popular types is known as Flexible Benefits which are governed by section 125 of the Internal Revenue Code. Flexible Benefits, commonly referred to as “Cafeteria Benefits” or “Flex Benefits,” work much like a cafeteria where you have the option to pick and choose which items you’d like. This allows you to select the benefits that are of most value to you and forgo those benefits less important to you. While every benefit an employer offers under a Flexible Benefits Plan may not be offered on a pre-tax basis, many of the
benefits to choose from are. For example, dental, vision, cancer, medical bridge, accident and intensive care benefits are commonly offered on a pre-tax basis.
Other common pre-taxed benefits offered in Flexible Benefits packages are Flexible Spending Accounts. Flexible Spending Accounts essentially work to help you pay out-of-pocket medical costs while increasing spendable income by electing a specified amount of pre-taxed money to be deducted from your paycheck each pay period. These dollars are then set aside in a reimbursement account and subtracted from your gross earnings before any taxes are taken. The two most popular components of Flexible Spending Accounts are Healthcare Flexible Spending Accounts and Dependent Care Flexible Spending Accounts. Healthcare Flexible Spending Accounts set aside money to be used to pay for out-of-pocket medical expenses including deductibles, co-payments, dental costs, vision costs, prescriptions and some other healthcare costs not covered by health insurance. Dependent Care Flexible Spending Accounts set aside money to be used to pay for expenses including childcare, eldercare, or services for a disabled dependent.
How Do Flexible Spending Accounts Work and How Do They Benefit Me?
When you contribute pre-tax dollars to a reimbursement account, you lower your taxable income. Therefore, you pay less in taxes and increase your spendable income.
For example, John has a daughter who needs braces that will cost $1,200 over the next year. He also has a $250 major medical coverage deductible. Plus, he needs glasses costing $230. That totals up to $1,680 for the year, or $70 per bimonthly pay period.
With a Healthcare Flexible Spending Account, John can increase his spendable income. See the chart below to see how.
Healthcare FSA illustration:
John’s status: Married, two fed/state exemptions
Bimonthly salary: $1000
Healthcare FSA: $70 per pay periodSource: piercegroupbenefits.com