Pre and Post-Tax Benefits: Understanding the Difference

The taxation on supplemental health benefits, like disability and accident insurance, can vary. Pre-tax and post-tax benefits can both result in savings, but it’s crucial to understand the differences between the two so employees know what’s best for their income.

What are pre-tax benefits?

In short, with pre-tax benefits, the benefit cost is deducted from an employee’s paycheck before income and employment taxes are applied. As a result, this lowers the total income amount that is taxed, which reduces the income taxes the employee is responsible for paying.

Internal Revenue Code (IRC) Section 125 allows for these payroll deductions to be taken pre-tax for certain benefits. Eligible benefits that are commonly pre-taxed are:

Flexible Spending Accounts (FSAs)
Health Savings Accounts (HSAs)
Cancer insurance
Accident insurance
Dental and vision insurance

An example of how pre-taxing benefits can be most beneficial is when it comes to employees’ HSAs and FSAs. By pre-taxing reimbursement account contributions, employees will experience immediate savings since they’re contributing prior to taxation. Choosing to pre-tax their benefits will give employees a tax break on their current taxes, which may be valuable depending on their financial situation. Also, reimbursements from these plans for qualified medical expenses are tax-free. So, employees save at the time of contribution for the reimbursement account and when the benefits are paid.

Learn How a Section 125 Plan Works

What are post-tax benefits?

Post-tax benefit contributions are taken from an employee’s paycheck after taxes have already been deducted. This then means that the employer and employee will owe more income and employment tax, but the employee generally won’t owe any income tax on the benefits when they use the plan in the future.

One of the most common plans paid for on a post-tax basis is disability insurance. If the disability premium is deducted from their salary on a pre-tax basis, or if the employer pays the premium, the benefits will be taxable at the time they receive claim payment. It is typically preferred to deduct premiums post-tax because employees won’t have to pay taxes on the benefits they receive in the future if they were to experience a disability.

Are there advantages to either option?

It’s important to understand the difference between pre- and post-tax benefits because choosing one or the other could be disadvantageous to the policyholder, depending on the type of benefit. Pre-tax contributions reduce overall taxable income and provide an immediate tax-break for employees. It’s advantageous to pre-tax benefits when savings on current taxes is needed. However, with pre-tax contributions, taxes could be owed down the road when the benefits are used.

Post-tax contributions for benefits do not reduce overall tax burden but can provide future relief when it’s time to utilize the benefits. They may not provide tax breaks on the front end, but a post-tax deduction can result in savings in the future

This blog is up to date as of July 2020 and has not been updated for changes in the law, administration or current events.