Free Money! How to Make Pretax Deductions Work for You
Most people looking to save money in their household budgets take one of two routes: Either they cut back on discretionary purchases, or they use coupons and discounts to make those discretionary expenditures cost less. Neither of those techniques, though, touches the part of the budget dedicated to necessities -- the expenses that absolutely have to be paid. But what if there was a way to slash spending on non-negotiable costs like child care, dental work and transportation?
Well, there is: Most employers allow workers to deduct money for basic expenses before they pay taxes on them. Some of these pretax withdrawals -- like deposits into 401(K) accounts and health insurance programs -- are well known. However, there are a lot of less-discussed withholding options that you can use to cut your tax bill. For example, you may be able to deduct money for child care, transportation expenses, parking permits, dental care, eye care and even tuition. You can even pay for long-term care insurance that will provide for you in case of disability.
The immediate value of these deductions is obvious: By pre-allocating funds to those basic necessities, you can avoid paying taxes on money that you were going to spend anyway. Even better, pretax deductions can also cut the state, federal and FICA taxes that you pay on the rest of your money. Depending upon the amount that you set aside, it's possible that you could shift yourself into a lower tax bracket, greatly reducing your tax burden.
That's exactly how it worked for one person to whom I talked about this topic. Her decision to set aside $160 per paycheck in pretax deductions slid her down into a lower tax bracket. Ultimately, the lower rate, combined with the money that she saved on the deductions themselves, meant that the actual reduction in her bi-weekly paycheck was only $70. Given that she was already committed to spending the $160 that she withheld, this translated into an effective savings of $90 every two weeks, or $2,340 per year.