What does "Pre-Tax" Mean?

What does “Pre-Tax” mean?


At employee benefit open enrollment meetings, there is a word that gets thrown around often: “Pre-Tax”.  This is referenced as a great benefit, but there is typically a lot of confusion about what it actually means.
 
There are a number of benefits that are typically available “pre-tax” through payroll:
 
Medical Insurance
Dental Insurance
H.S.A. Contributions
F.S.A. Contributions
 
In the example, let’s focus on how contributions to an H.S.A. work through payroll.  
 
Taxes listed below are for a single person making between $39,475 and $84,200:
 
Income Tax:
State (MN): 7.05%
Federal: 22%
 
Payroll Tax (FICA):
Social Security: 6.2%
Medicare: 1.45%
 
Total Taxes: 36.7%
 
When you contribute to a health savings account (H.S.A.) through payroll “pre-tax”, you will pay none of the taxes listed above on the money you put into your account.  This means that for every $100 that you contribute into your H.S.A., only $63.30 of your own money is being put into the account.  You are receiving $36.70 of free money!
 
Let’s say you contribute the maximum annual H.S.A. limit of $3,500 through payroll divided out throughout your 26 payroll deductions.
 
$3,500 x 36.7% = $1,284.50 of free money!
 
Of the $3,500, you will only contribute $2,215.5 of your own money.
 
The money in the H.S.A. is your money, and there are no requirements to use it in any given timeframe. When you use it for medical, dental, vision bills you will not pay any taxes. 
 
There is no other account available on the market that allows an opportunity to avoid taxes on contributions AND when you withdraw/use it. That is why the IRS puts such a small contribution limit ($3,500 single, $7,000 family) on the health savings account.  If you can afford to contribute the maximum, it is extremely important to do so.