When it comes to your employees’ paycheck, it’s important to be well-versed on all forms of payroll deductions so you can explain how they work. Conversations about pre-tax payroll deductions often take place during onboarding. As you educate your employees about their options, it’s also a great time to emphasize the value of the benefits you offer employees.
Additionally, employers should be on the lookout for changes in policies that will affect the total compensation you offer employees. This is especially true when it comes to limits for retirement savings and 401(k) contributions. But don’t worry, we’ve got you covered. Here’s everything you need to know to help employees make the most of pre-tax payroll deductions this year.
What Are Pre-Tax Deductions?
Pre-tax deductions are deductions applied to an individual’s gross income, thereby decreasing the amount of wages upon which local, state, and federal taxes will be owed. In addition to income tax liabilities, pre-tax deductions also decrease a worker’s required contributions to Medicare and Social Security.
One goal of making certain payments pre-tax is to provide incentive for people to plan ahead for various life events, such as retirement and medical expenses. A post-tax deduction is money taken out of an employee’s paycheck after taxes are withheld and does not reduce the amount of taxes that an employee must pay to state or federal entities.
| Pre-Tax Deductions | Post-Tax Deductions | |
| Definition | Deductions taken from an employee’s gross pay before taxes are applied. | Deductions taken from an employee’s net pay after taxes have been applied. |
| Examples | Health insurance premiums, 401(k) contributions, HSA contributions. | Union dues, charitable contributions, Roth IRA contributions, garnishments. |
| Effect on Taxable Income | Lowers taxable income, resulting in lower income tax. | Does not reduce taxable income, so no impact on income tax. |
| Common Use Cases | Used to reduce current tax burden, often for retirement or health savings. | Used for expenses or investments where tax-free growth or specific needs (e.g., garnishments) apply. |
What Are the Different Types of Payroll Deductions?
Employees should understand there are two types of payroll deductions: involuntary, or mandatory deductions, which include taxes, wage garnishments, and fines; and voluntary deductions, which are amounts an employee has chosen to have subtracted from their gross pay often related to healthcare costs, childcare costs, or retirement funds.
What Are Examples of Pre-Tax Deductions?
Example of pre-tax deductions include the following:
Retirement Savings
Contributions to a 401(k) plan, a 403(b) plan, or a Government Thrift Savings Plan are deducted from an employee’s gross earnings prior to any taxation. Every dollar placed into one of these retirement savings plans reduces an individual’s taxable income by an equal amount.
The contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan for 2025 is $23,500. For employees over age 50 who participate in any of these plans, there is an additional allowance of $7,500 per year considered “catch-up” contributions. Participants between 60-63 years old can make catch-up contributions up to $11,250, due to a change enacted in Secure 2.0.
Often the best way to educate employees about retirement plan savings is to partner with a provider, like a financial advisory firm, to make sure they understand how specific plans work. Providing an expert will help employees make the best decisions about how to move forward.
401(k) Contribution Limits
As an extra incentive, employers may offer to match employee retirement savings dollar for dollar to a certain amount. While the general contribution from an employer typically ranges from 3-6% of an employee’s pay, the IRS defines an overall contribution limit to an account each year. The maximum amount of total contributions from both employee and employer to a 401(k) is $70,000 in 2025.
Employer High Deductible Health Plans and Health Savings Accounts
If your company offers the combination of a high deductible health plan along with a pre-tax health savings account, an employee may be able to save pre-tax dollars to pay for services and benefits that a high deductible health plan fails to cover. If your business doesn’t offer this option to employees as a group, they can still arrange for personal health savings accounts, although they will be funded with after-tax dollars.
Encourage employees to speak to your company’s human resources department for more information. Here’s a pro-tip: to help employees understand the cost differences between high-deductible plans and PPOs, you may want to consider launching a microsite during open enrollment that explains and compares the cost differences of different health situations and helps them decide what is best for their current set of circumstances.
Flexible Savings Accounts
Flexible Savings Accounts or FSAs, if your company decides to offer them, can vary as to availability and the maximum amount of annual contributions. Typically, they are used for IRS-approved medical care, procedures or supplies, or adult-care or childcare expenses. Eligible expenses should be made available in your company’s benefits manual or through your HR department.
This is a great benefit for families who are aware of upcoming expenses related to medical procedures or childcare and would like to plan ahead. Again, when you explain this benefit to employees, be sure to communicate that it is helpful because the money is taken out before taxes are withheld, therein reducing the amount that your employee will pay in taxes. The average worker saves about 30% by using an FSA because of the immediate tax savings.
If this is something you offer, be sure to emphasize that only so much can be carried over for the next year. For 2025, the maximum amount an employee can contribute is $3,300 for a Health FSA, and the maximum amount that can be carried over is $660. Dependent Care FSA contribution limits will stay the same at $2,500 for those married filing separately and $5,000 for those who are single or married filing jointly.
Group Insurance Plans
Group health insurance plans — including medical care, dental care, vision benefits, life insurance, and short and long-term disability insurance — deduct an employee’s share of the premiums out of their pre-tax wages. Here’s another tip: when you are educating employees about the costs of your group insurance premiums, make sure your employee is also aware of your organization’s contribution to their insurance and benefits costs. This helps the employee understand their total compensation.
How do Pre-Tax Deductions Impact Taxes?
For every dollar contributed to a pre-tax retirement account, flexible spending account, or insurance plan, an employee’s taxable income is decreased accordingly. This decrease applies not only to federal income tax, but to Medicare and Social Security deductions as well. Finally, for the majority of states with state income tax, their assessment of an employee’s income begins with the employee’s Adjusted Gross Income (AGI) or the amount of wages after deduction of these pre-tax costs and contributions.
Rules and Limits Change Annually
The rules, regulations, allowable maximums, and limits to such programs can change annually. Processing an individual’s taxes correctly is very challenging without the latest information and the right experts who continue to monitor ever-changing regulations.
To ensure you are staying compliant, be sure to stay updated when limits and policies change. If you are using technology to manage HR tasks, some HCM software providers alert you when an employee is contributing pre-tax deductions over the maximum amount.
How Paycor Helps
We’re proud to keep more than 30,000 organizations informed and compliant with federal and state laws and regulations. Since 1990, Paycor has maintained a core expertise in payroll and compliance. We established our compliance expertise in the Cincinnati tri-state area, one of the most complex tax jurisdictions in the country. If you’re looking for a trusted provider to help you manage the complexities of payroll tax, look no further than Paycor. Take a guided tour to learn more.