| No Pre-tax | Using Pre-tax | Pocket Change or “Feels Like” | “Real” Economic Benefit |
1. Wages: | $20,800 | $20,800 | - | - |
| Explanation: Gross wages don’t change if she redirects dollars or not. |
2. Contributions: Health Insurance Flexible Spending |
- - |
($ 1,040) ($ 600) |
- - - - |
| Explanation: When Annamakes pre-tax contributions for health insurance and redirects out-of-pocket expenses into a flexible spending account, it actually feels no differently because she has to pay those expenses anyway. |
401(k) ($25/pay) | - | ($ 600) | $ 600 less | $ 600 more |
| Explanation: If she puts $25 per pay into the 401(k) retirement plan, it feels like $600 per year less in her pocket. However, remember that the money is still hers, but it’s just redirected to savings instead of her pocket. |
3. Tax Calculations: |
FICA Wages | $20,800 | $19,160 | - | - |
| Explanation: Anna’s FICA wages are lower because of the health insurance and flexible spending account contributions. This is the amount on which FICA (and State/Local, generally) taxes are calculated.* |
FICA (7.65%) | ($ 1,591) | ($ 1,466) | $ 125 more | $ 125 more |
State/Local | ($ 936) | ($ 862) | $ 74 more | $ 74 more |
| Explanation: *The result is Anna’s tax calculations for both FICA and State/Local are lower, putting more dollars back in her pocket. |
Federal Wages | $20,800 | $18,560 | - | - |
Deductions/ Exemptions | Explanation: Anna’s federal taxable wages have been reduced by all three of her pre-tax contributions, which at this point, feels no differently. This is the amount she will include on her 1040 form. |
($21,250) | ($21,250) | - | - |
Taxable Income | $ 0 | $ 0 | - | - |
Child Tax Credit | ($ 2,000) | ($ 2,000) |
|
|
Saver’s Credit** | $ 0 | ($ 300) | - | - |
Net Total Tax | $ 0 | $ 0 | - | - |
| Explanation: After her deductions and exemptions, her taxable income is still zero. **Although she would qualify for the child tax credit (and now saver’s credit due to her 401(k) contribution), she doesn’t have any tax owed by which the credits, can be reduced. |
Earned Income Tax Credit | $ 4,976 | $ 5,461 | $ 485 more | $ 485 more |
Explanation: Another added benefit of lowering federal taxable wages is the earned income tax credit (which is a refundable credit) increases, putting an additional $485 in her pocket. |
4. Other:
401(k) match | - | $ 416 | - | $ 416 more |
| Explanation: But wait! Remember Anna’s employer matches up to 2% for 401(k) contributions. That’s an additional $416 in her retirement account. |
5. Conclusion:
Using pre-tax contributions, Anna will actually have
more in her pocket every year! | $ 84 | |
The “real” economic benefit is far greater when you
factor the tax reduction, additional EITC, and the
retirement savings with the company match. | $ 1,700 |
