Life Insurance: Pre-Or-Post Tax? Understanding The Basics

Life insurance is a benefit that can be paid for with pre-tax or post-tax deductions. Pre-tax deductions are taken from an employee's paycheck before taxes are calculated, reducing taxable income and thus income tax liability. Post-tax deductions are taken from an employee's net salary and do not reduce taxable income or affect how much income tax is owed.

Pre-tax life insurance and tax deductions

Life insurance premiums are generally not tax-deductible. However, there are certain scenarios where the Internal Revenue Service (IRS) treats life insurance premiums differently, and tax deductions may be applicable.

Employer-Provided Life Insurance

If an employer provides life insurance as part of an employee's compensation package, the IRS considers it income, and the employee is subject to taxes. However, these taxes only apply when the insurance coverage exceeds $50,000. The premium cost for the first $50,000 in coverage is exempt from taxation.

For example, if an employer provides an employee with $50,000 in life insurance coverage, the employee doesn't have to pay taxes on this benefit. On the other hand, if the employer pays for a $100,000 life insurance policy, the employee must pay taxes on the portion that exceeds the $50,000 threshold. The taxable amount is based on IRS tables and is considered additional taxable income.

Business-Related Expense

Life insurance premiums are tax-deductible as a business-related expense. The most common type of deduction in this category is group-term life insurance, where employers offer life insurance coverage as a benefit to their employees.

The IRS considers employer-provided group term life insurance tax-free if the policy's death benefit is less than $50,000. Coverage exceeding this amount must be paid post-tax.

Divorce Agreement

If you are divorced, and your divorce agreement was executed before 2019, any life insurance premiums you pay as part of that agreement may be tax-deductible. These payments are considered alimony and can be deducted from your income taxes.

Pre-Tax Benefits

It is important to understand the difference between pre-tax and post-tax benefits when discussing tax deductions. Pre-tax deductions offer immediate tax savings, but they lower an employee's taxable income. In contrast, post-tax deductions don't provide immediate tax relief, but they won't be taxed when the benefits are used in the future.

Pre-tax benefits are deductions that an employer sets aside before calculating payroll taxes. With these deductions, employees pay lower taxes because their taxable income is reduced. However, employees may owe taxes when they use the benefit in the future, such as with a 401(k) plan, which is taxed upon withdrawal in retirement.

State and Local Taxes

It is worth noting that pre-tax benefits may not be exempt from all state and local taxes. Employers should stay updated with their state and local tax laws to determine which benefits are exempt. For example, while adoption assistance is exempt from federal income tax, it is still subject to Social Security, Medicare, or Federal Unemployment Tax Act (FUTA) tax.

Post-tax life insurance and tax deductions

Post-tax life insurance is a payroll deduction taken from an employee's paycheck after taxes have been withheld. Post-tax deductions do not lower an individual's overall tax burden as they reduce net pay rather than gross pay. However, the employee will not owe any additional income tax on the benefits when they use them in the future.

The most common type of post-tax life insurance deduction is group-term life insurance. Group-term life insurance is a contract issued to employers, who then offer life insurance coverage as a benefit to employees. If an employer offers group-term coverage, they can make post-tax deductions on premiums they pay on the first $50,000 of benefits per employee.

Life insurance premiums are tax-deductible as a business-related expense. This type of deductible is often called a life insurance post-tax deduction. For employers, life insurance premiums are tax-deductible as a business expense.

While life insurance premiums are not usually tax-deductible, there are certain circumstances where they can be. If you are not directly or indirectly a beneficiary of the policy, you may be able to deduct the premiums as a business expense. Additionally, if you are divorced and your divorce agreement was executed before 2019, any life insurance premiums you pay as part of that agreement are considered alimony and can be deducted from your income taxes.

Pros and cons of pre-tax benefits

Pre-tax deductions offer immediate tax savings for the employee. However, any money that's put aside from their paycheck before taxes will result in a lower taxable income. Pre-tax deductions reduce income tax liability in the near future for employers and their employees. But the employee sometimes owes taxes when they use the benefit they "prepaid" for. For example, an employee who retires will owe taxes when they withdraw money from a pre-tax 401(k) plan.

• Health insurance plans
• Health reimbursement arrangements (HRAs)
• Health savings accounts (HSAs)
• Pre-tax retirement plans
• Commuter benefits

On the other hand, post-tax deductions don't provide immediate tax relief for your employees. Instead, these benefits won't be taxed when they are used in the future. Post-tax deductions offer employees the advantage of higher take-home pay. This is because individuals have already paid taxes on contributions. While post-tax contributions don't lower tax burdens, they do provide long-term relief for employees.

• Stipends
• Post-tax retirement plans
• Disability insurance
• Life insurance premiums
• Wage garnishments

Pros and cons of post-tax benefits

Post-tax benefits are payroll deductions that an employer sets aside after calculating payroll taxes. They reduce an employee's net pay, not gross pay, meaning employees will still owe taxes on them. When employers deduct benefits from an employee's paycheck on a post-tax basis, they (and their employees) end up paying more in income tax than they would with pre-tax benefits. This is because many pre-tax benefits are federally tax-exempt.

Some employees prefer post-tax benefits over pre-tax benefits that are tax-deferred rather than exempt. For example, someone who withdraws from a post-tax 401(k) won't need to pay taxes on the money when they take it out, as all federal and state income taxes would have already been paid.

Except for wage garnishments (governed by court orders and IRS regulations), post-tax contributions are voluntary payroll deductions.

Although post-tax payroll deductions don't reduce an employee's taxable income, they give employees more control over their total compensation package. Many types of post-tax benefits give employers the opportunity to go above and beyond for their employees.

A wage garnishment is a court-ordered deduction from a worker's paycheck. Child support, alimony payments, and unpaid loans are common reasons for them. Employees can't opt out of these deductions – they're compulsory by order of law. So employers are responsible for calculating garnishment amounts and withholding the sum from an employee's paycheck until their debt is cleared.

Post-tax retirement contributions are great for employees who want to save more money but don't need the tax break that comes with pre-tax deductions. There are three main types of post-tax retirement plans:

• Roth IRA – Employees pay income taxes on the money they contribute to a Roth IRA but not when they withdraw it.
• After-tax 401(k) options – Employees can save pre-tax and after-tax money in the same account. After-tax 401(k) contributions happen after pre-tax payroll deductions and employer contributions, allowing employees to save more of their paycheck toward retirement.
• Roth 401(k) – Employees contribute after payroll deductions, and the earnings grow tax-free (assuming no withdrawals before 59 1/2). The same limits that apply to a tax-deferred 401(k) apply to a Roth 401(k).

Note: Employees must specify post-tax contributions when they open their retirement plan account – these funds can't be converted from pre-tax to post-tax after they're already saved in the account.

Employees choose the coverage they want with company-sponsored life insurance policies and make payments via payroll deduction on a post-tax basis. For employers, life insurance premiums are tax-deductible as business expenses.

Group-term life insurance is the most common type of employer-sponsored life insurance. Group-term life policies are pooled into a single policy and cover all employees in the group, offering death benefits for members who pass away while they're employed.

Employers can deduct premiums paid on the first $50,000 of benefits per employee if they offer group term coverage, but these deductions will be made after tax.

A stipend is a lump-sum benefit an employer provides to account for the cost of meals, transportation, and other living expenses. They range from $50 to over $200 per month and they help employees pay for various out-of-pocket expenses. Types of stipends include student loan repayment, career and professional development, relocation living expenses, and meals and transportation.

While regular salary/wages for W-2 employees are taxable, a stipend isn't classified as a wage. In addition to income tax, employers don't withhold the 6.2% Social Security or the 1.45% Medicare tax on stipends. They will, however, still need to pay state and federal income tax on those amounts.

A lifestyle spending account (LSA) is a post-tax benefit employers can offer to help employees manage healthcare, childcare, health and wellness, and education expenses (or anything else, really). They're similar to an FSA, but they offer ultimate control over how and when employees use their benefits.

Employees can access funds in an LSA up to a certain dollar amount per year, and the account balance rolls over from one benefit year to the next. When employees spend money from LSAs, they pay income tax on it.

Examples of pre-tax and post-tax benefits

Pre-tax benefits are deductions from an employee's paycheck before federal income and employment taxes are applied. They lower the total income amount taxed, reducing the income taxes the employee is responsible for paying. However, the employee might owe taxes in the future when they use the benefit. For example, an employee who retires will owe taxes when they withdraw money from a pre-tax 401(k) plan.

• Health insurance plans
• Health reimbursement arrangements (HRAs)
• Health savings accounts (HSAs)
• Flexible spending accounts (FSAs)
• Dental and vision insurance
• Retirement plans
• Disability insurance
• Commuter benefits

Post-tax benefits are payroll deductions that are taken from an employee's paycheck after taxes have been deducted. They do not lower the individual's overall tax burden, but the employee typically won't owe any income tax on the benefits when they use them in the future.

• Stipends
• Post-tax retirement plans (e.g., Roth IRA and 401(k))
• Group-term life insurance
• Wage garnishments
• Lifestyle spending accounts (LSAs)

Frequently asked questions