- When you contribute to a 401k plan you lower your taxable income by the amount you put in. This can substantially reduce the amount of taxes you pay, especially if you contribute the maximum to the plan. For instance, an employee who makes $40,000 a year and diverts 25 percent of his pay to a 401k plan pays federal income tax on only $30,000 in wages.
- If you are covered by a high-deductible health plan, you can get additional tax savings by opening a health savings account as well. If your employer offers a health savings account, you can add money to that account through payroll deductions, and those payroll deductions can come out on a pre-tax basis. That gives you an immediate tax break and allows you to save money on your health care expenses.
- A flexible spending account allows you to put money aside on a pre-tax basis and use those funds to cover eligible health care and medical spending. Opening such an account can be a smart move, particularly if you anticipate a large medical expense in the coming year. For instance, you could put aside pre-tax money to pay for dental work you know you will have in the next 12 months. The money you take out is not subject to taxation, making those funds cheaper to you. It is important to note, however, that you must use all the money in your FSA by the end of the calendar year or forfeit the remainder on December 31.
- Some employers allow workers to have money deducted from their paychecks and held in an account designed to pay for covered expenses incurred by their dependents. These types of accounts use pre-tax dollars, meaning that the money deducted is not subject to federal income taxes. Workers can check with their employers for specific details about these accounts, including which costs are reimbursable from the accounts and the annual dollar limits for contributions.
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