True or false: Offering the highest salary is the only way to retain your best employees.

False! 

Employees appreciate more than a competitive salary. An effective tool for recruiting and retaining employees is to offer a benefits package. Benefits like health insurance and retirement plans are enticing and provide a security net for a health scare or during retirement.

But you might wonder how benefits affect how you pay your employees, which benefits you should withhold, and when.

This article defines pre-tax and post-tax benefits with examples of each, so you can understand the advantages and disadvantages of each and what they mean for your business.

Pre-Tax Benefits vs. Post-Tax Benefits

In the modern world of employment, quality of life and feeling valued is essential for a productive workforce.

Offering a robust benefits package and letting employees have some control over the process helps them feel secure in their jobs and able to manage their finances better.

Generally speaking, pre-tax benefits grant an immediate tax break, reducing the amount of money employees will owe locally, at state-level, and federally.

Post-tax benefits give employees a bigger paycheck. You must know the ins and outs of benefits to help employees decide what’s best for their income.

Knowing when and how to withhold benefits can be confusing. When you partner with a payroll company like ConnectPay, you never have to worry about managing these processes alone.

Our Connected Model ensures you’re never more than a phone call away from getting the answers you need. Speak to local tax experts and come up with a plan to ensure your employees get the right benefits at the right time.

What Are Pre-Tax Benefits?

As the name suggests, the value of each benefit is deducted before federal income and employment taxes. By withholding deductions before taxes, the employee’s taxable income is lowered, reducing income taxes owed, and providing an immediate tax break for employees.

Something to make employees aware of is that if they use the benefits, they might owe taxes in the future.

For example, an employee that retires will owe 10 percent income tax if they withdraw money from a pre-tax 401k before they are 59 ½ years old.

Pro tip: Not all pre-tax benefits are exempt from local and state taxes–check local laws to find out.

Medical/Dental Insurance

Health plans are often first on the pre-tax benefits list. As an employer, you deduct money from your employee’s gross pay to split the cost of health coverage that you purchase. Common health plans include group health, accident, dental, and vision.

A health reimbursement arrangement (HRA) also uses pre-tax funds. HRAs are employer-funded and help both parties save on healthcare costs.

Lastly, a health savings account (HSA) is also in the pre-tax group. Funded by you and your employee, employees can set aside pre-tax money to pay for healthcare expenses. Employees keep their HSA accounts even if they lose their job or quit.

401(k) Retirement Plans

Employees have the option to set up pre-tax retirement plans. Common examples include IRA plans, many 401(k) plans, and Thrift Saving plans. An employee’s taxable income reduces by an equal amount every time a dollar is deposited.

There are contribution limits, and if an employee wants to withdraw funds, they might have to pay taxes. Retirement plans are income tax-free but still subject to FICA and Social Security taxes.

Commuter Benefits

Employees who enroll for this benefit can pay for parking and transit expenses with pre-tax dollars. You deduct the monthly cost of their commute to work directly from their paycheck. Employees can use the money however they want, meaning they have options for getting to work.

Again, there are limits to how much an employee can claim. While you can offer commuter benefits pre or post-tax, it helps employees to provide them pre-tax to reduce their taxable income.

What Are Post-Tax Benefits?

Otherwise known as after-tax deductions, post-tax benefits are taken from an employee’s paycheck after taxes are deducted. You, as the employer, and your employees will owe more income and employment tax, but on the plus side, your employee won’t owe any taxes when they use the plan in the future.

IRA Post-tax Retirement Plans

Compared to traditional retirement plans, you contribute after-tax dollars to both Roth IRAs and some 401(k) plans. The draw of a Roth IRA is that your contributions and earnings on those contributions grow tax-free and are withdrawn tax-free.

The IRS sets dollar limits. You and your employees can make contributions up to those limits. The maximum amount is adjusted periodically to account for inflation.

Related: 401 (k) or Roth 401(k): Which is Right for You? | ConnectPay

Stipends

Stipends are usually paid to trainees, interns, and students to cover basic costs and expenses. However, they can also be offered to employees as an addition to their regular wage. Taxes aren’t deducted from stipends but are a form of taxable income, so employees must pay their own withholding taxes.

Employees might use stipends to cover expenses like fertility treatments, health and wellness programs, and job training.

Disability Insurance

This type of insurance can provide supplemental income to an employee who is disabled and can no longer work. The employee chooses whether they want to pay for the premium with pre-tax or post-tax dollars.

It’s probably best for employees to choose a post-tax disability premium so that they won’t have to pay taxes during a period when their finances might be tight.

Related: What to Know About Short-Term and Long-Term Disability | ConnectPay

What are Voluntary and Involuntary Deductions?

A voluntary deduction plan is when an employee gives permission to their employer to withhold money for specific purposes such as life insurance premiums, retirement savings plans, and paying union dues.

Conversely, involuntary deductions are deductions you’re required by law to withhold from an employee’s paycheck. Examples include federal income tax, FICA taxes, state disability, unemployment insurance, and court-ordered child support payments.

Pre-Tax Benefits vs. Post-Tax Benefits: Which is Better?

Now that you understand the benefits of both, you can start to build a package that benefits your small business and your employees. Advising employees builds a trusting relationship.

At ConnectPay, we cover your payroll needs. We understand that pre-tax, and post-tax deductions are tricky, and you might also be wondering how this affects payroll taxes and other laws.

We can provide you with the connections you need to local tax experts who will guide you through the process so you can manage tax compliance with ease.

For more about how we can help, including automated management of incomes and deductions during payroll processing, tax forms, filing, and compliance, check out our free resource, The Connected Guide to Small Business Payroll.

Are you offering pretax Section 125 deductions to your employees? Our team can help you update your Section 125 Plan Document in 7-10 days. Explore our new service Connect Section 125 to learn more!