Employee pre-tax deferral
The payroll tax deferral took effect on the 1st of September. It was implemented by President Trump.
Tax deferral simply explained, is the process of taking funds away from your salary (taxable income) to be put in a retirement savings account such as a 401K (non-taxable). In view of this explanation, a pretax deferral refers to funds taken away from your income before it is taxed, to be put into your non-taxable retirement savings account.
How does employee pre-tax deferral work?
A pretax deferral reduces your taxable income, as funds are taken and sent to your retirement savings account before the IRS gets a chance to tax your income.
You still have to pay the required amount of taxes on the deferred amount, however, that will be later in the future when you withdraw from the retirement account. Additionally, you will be paying the deferred taxes at a normal income tax rate which will most likely be lower at retirement than it was during your active working years, depending on your income.
Another deferral option that slightly differs is the Roth 401K is an after-tax deferral. Here, taxes are taken upfront even from the deferred funds but no taxes will be deducted from the amount at withdrawal.
Benefits of employee pre-tax deferral
Pretax deferrals are a great way to plan for your retirement and not worry about having to depend on family, friends, and social security benefits to survive. Additionally, they reduce your taxable income; what could be better?
Another advantage of tax deferrals is that they help you take advantage of the employer match that some employers offer.
An employer match is a form of motivation provided for employees who participate in salary deferral.
It is a situation where the employer offers a matching contribution set at a percentage of the employee’s contributions, and up to a certain portion of the total amount that the employee earns as a salary, thus, increasing the employee’s compensation package.
For example, for an employee whose employer agrees to match contributions for up to 5% of their salary, and the employee earns $2000 every week, and contributes 5% of his or her salary to the retirement savings account. If the employer matches the amount, the employee’s 401(K) principal balance will grow by $200 instead of the $100 deducted from her weekly salary.
This is literally a way of multiplying your savings for retirement.
If you want to begin to make salary deferrals, you must enroll with your employer. Usually, it is expected that you are 21 years or older. You may also be required to have spent a certain number of months in that job to access an employer’s match.
You will be enrolled in your employer’s retirement savings plans and be provided with a form where certain information will be required of you. The information that you will be required to provide includes the name of a beneficiary who will receive the money if you die.
In some companies, workers are automatically enrolled. You will have to find out this information and opt-out if you are not interested.
The amount of money you can contribute to your salary deferral varies depending on some factors such as your age. For example, in 2020, people who are younger than 50 years can not defer more than $19,500 to a 401(K) or 403(b) or $13,500 to a simple IRA.
People who are 50 years and above can defer an additional $6,500 in catch-up contributions to a 401(k) or 403(b) or an additional $3,000 into a SIMPLE IRA.
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