A Pre-tax deduction refers to things done the governments preferred way that reduce the amount of income you pay taxes on. For example if you make $50,000 a year and you put $10,000 into a 401(k) (one of the governments preferred savings methods) then you will only pay taxes on $40,000 a year. This is a nice way to reduce the amount of taxes you pay at the end of the year and with things like a 401(k) the money is taken out of your paycheck before you see it, so you never even have the contributed money. Not only does this prevent you from missing a deposit to your retirement it makes your taxes simpler because you employer tells the IRS that you only earned 40,000.
Post tax deductions are things like mortgage interest, IRA deductions etc that are tax deductible, which means (Normally) when you pay $5,000 of mortgage interest you will get the tax you paid on that $5000 back at the end of the year. This is what we call a tax refund, it is money you over paid to the government throughout the year. It is like getting change at the grocery store, only you have to wait months and fill out a lot of paperwork to get it.
Both post-tax and pre-tax deductions are tax deductible, which means you do not have to pay taxes on them. The difference is that you don’t get all of your money from post-tax deductions up front. The government still taxes the money and then gives it back to you when you file your taxes. Maybe you don’t mind giving Uncle Sam an interest free loan or think he can spend your money better than you can but I don’t think so.
When I moved to my new job recently I was disappointed to learn that they did not do a matching 401(k) contribution. In order to make up for my disappointment they offered me a signing bonus (read onetime bonus) I asked for that money as part of my salary(so I could have it every year), which they were happy to do. (Always negotiate your salary and benefits) I had intended to roll over my old 401(k) to the new one for my company, but instead decided to roll it into a traditional IRA with my old friends over at Fisherwealth. (To the best of my knowledge no relation, but we have done business together for years). I can now take the money I negotiated and deposit it to my new IRA. But, what am I to do about the money being a post-tax deduction? I am being taxed on that money even though it is tax deductible.
This is when I realized that if you know how things work you can make almost anything a pre-tax deduction. When I started my new job they asked me to fill out a form to determine how much money the federal and state governments should take out of my income every paycheck. To pay my taxes. Now this isn’t a nice simple form like take out $100 per check, no it is a complicated formula so you most people don’t realize what is going on. But, as I have written about here, you can get your tax refund all year long by filling out this form properly.
This way all your tax deductible expenses including your child credits etc, can be pre-tax. The IRS has a handy little calculator to determine how to eliminate your federal refund and get the most out of your paycheck. It is here if you want to check it out.
Do you prefer to get a big refund or a bigger paycheck?
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