Pre-tax contributions

What pre-tax contributions are

Pre-tax deferrals, also called traditional deferrals, are left out of the employee’s federal taxable wages in Box 1 of Form W-2 and reported in Box 12 with code D. They are still subject to Social Security and Medicare taxes. The money grows tax-deferred and is taxed as ordinary income when it comes out.

Why it matters to employers

Payroll has to treat the two taxes differently: reduce federal income tax wages, but not Social Security and Medicare wages. It also helps to offer Roth alongside pre-tax. Under the Roth catch-up rule, higher-paid employees must make catch-up contributions as Roth, so a plan with no Roth option leaves them unable to make catch-up contributions at all.

Example

An employee earning $80,000 defers 6% pre-tax, or $4,800. Her Box 1 wages are $75,200, while her Social Security and Medicare wages stay at $80,000. In the 22% federal bracket, she pays about $1,056 less in federal income tax this year.

Common mistakes

• Exempting pre-tax deferrals from Social Security and Medicare withholding.

• Coding Roth deferrals as pre-tax in payroll, or the reverse.

• Describing pre-tax savings as tax-free. The tax is deferred, not removed.