The difference between pre-tax income vs post-tax income is something a lot of people don’t know and overlook whenever they get paid. It’s not until you start to take a closer look at your paychecks that questions start to popup.
It’s crucial for you to know the difference between gross pay (pre-tax, etc.) and net pay (post-tax, etc.) which is your actual income so you can plan your finances better. The only time get these two numbers, gross pay and net pay is when they see their income tax documents once a year.
Your annual salary doesn’t tell the full story. With all that out of the way let’s talk about the differences between pre-tax and after-tax pay and what your income really looks like.
What is Pre-tax Income?
Pre-tax income in short is your total income before you pay your taxes but after you’ve subtracted your deductions, otherwise known as gross income. Some pre-tax deductions you’ve probably heard of include investment account, 401(k), Roth IRA and HSA. These allow you to deduct or take money from your pre-tax income and make contributions to these accounts before the government gets their share.
Here’s an example for someone with a six figure salary, but this works for everyone.
If you take your $100,000 salary and invest 15% of it in a self directed 401(k), which equals $15,000; your pre-tax income is now only $85,000 and that’s what you get taxed on.
So rathe than paying taxes on a $100,000 you pay the tax rate for someone making $85,000. Making contributions like this keeps more money in your pocket and reduces your taxable income.
What is Income After Tax?
After tax income or your net income is the money you make after your tax deductions are made. Your taxable income will determine which tax bracket you fall into thus charging you at a predetermined tax rate. These tax brackets’ percentage range from 10% to upwards of 50%, which are deducted from your salary. This simply means that the more taxable income you have the more you pay in taxes.
You might’ve noticed by ow that your income after taxes if far less than your pre-tax income. So when setting up your budget it is pointless to go off of your gross pay because you never get that full amount paid to you.
Pre-tax income vs. income after tax: what’s the difference?
When you ask people how much money they make they often refer to their salary or their hourly pay rate. Both these figure are pre-tax numbers and equate to a dollar amount that the individual doesn’t actually receive.
The problem is, when they do actually get paid via check or direct deposit they’re receiving post-tax income.
Here are some commonly found deductions you might see on your paycheck:
- Federal: Based on your gross income and the information on your W-4
- State and/or local (if applicable)
- FICA: the U.S. Federal payroll tax for Social Security and Medicare
- Insurance: health, dental, group life.
- Savings: 401k, pension, Health Savings Account (HSA)
What left after all these deductions is your net pay, and the actual dollar amount you get to take home.
Its common for people to fall into this trap of thinking they make way more money than they actually do. This is why you need to think more about the money you keep and less about the money you earn.
Another Example of pre-tax income vs. income after tax
Meet Josh. Josh has a salary of $50,000 per year. That means Josh has a pre-tax income of $50,000 but in reality he only makes $37,500 a year (his post-tax income). The problem is Josh still makes his budget around taking home $50,000 a year which we know it’s the case.
|Josh’s Income: Pre-tax vs. Post-tax|
|Net Pay or Income after Taxes||$37,500|
Don’t fall into the same trap as Josh, thinking he makes $50,000 a year when he actually receives $37,500 in pay after taxes. In Josh’s mind he continues to buy things way more expensive than they should be because he has the belief that his income will be enough to pay for them. She books lavish vacations and upgrades to a new car. By the time the bills come rolling around it might be too late. Josh will be strapped for cash and have to make some tough decisions.
Have you ever felt like you work hard all year round to make a good salary just to find out you never have enough money based on what you thought you earned? If so it’s time to take a step back and first see what you can do to reduce your taxable income. To make living off of your reduced net pay consider implementing frugal living tips to help budget your money more efficiently without having to pinch every penny.
Investing in pre-tax and post-tax accounts
Always be making your 401(k) contributions. This will lower the amount of taxes you pay and your company might even have a money match program. In some instances you can put $2,000 into your 401(k) and your employer will give you another $2,000 for free.
Same goes for HSAs and other investment/retirement accounts. If you don’t contribute to these accounts to the maximum amount you just giving your money away to the government which no one likes to do. Your hard earned money is better off in your accounts anyways.
Post-tax accounts examples include ROTH IRAs, brokerage accounts, CDs, mutual funds, index funds, and education accounts, like 529s or ESAs.
How to figure out your after-tax income
It’s a lot easier than you probably think to figure out what your pay looks like after taxes. Take all the guesswork out of it by using a paycheck calculator. Two other tools to try out are the NEFE calculator and a take-home pay calculator.
Pre-tax income is far greater than after-tax income depending on your tax bracket. That being said it’s advised to make as many pre-tax contributions to investment accounts as possible to reduce your current tax burden.
Taxable income is the amount of money that determines a person’s or business’ tax liability. Pre-tax income is the amount of money a person or business makes before taxes.
Pre-tax dollars is your gross income which is the amount of money you make before taxes and expenses are deducted. After-tax dollars can be calculated by looking at your gross income or salary and subtracting your taxes based of which tax bracket you’re in.
When funding your lifestyle and crafting your budget don’t make your decisions off of your salary. Instead plan ahead and use your post-tax income. Don’t be fooled by huge loans banks pre-qualify you for based off your pre-tax income. Do your research and better understand what money you actually keep, not the money you make.