Calculating savings when paying pre-tax
About this video
Luke and Jess are in the 24% tax bracket and pay $250 a month for childcare. The video finds the gross income needed to cover $3,000 a year with after-tax dollars by dividing by 0.76, then shows that paying through a pre-tax dependent care FSA saves 24% of $3,000, or $720 a year.
You'll be able to
- find the gross income needed to cover an expense with after-tax dollars.
- explain why we divide by (1 - tax rate) rather than multiply.
- calculate the tax saved by paying an expense with pre-tax dollars through an FSA.
Key words
- After-tax dollars
- Money you have left after income tax has been taken out.
- Pre-tax dollars
- Money set aside before income tax is calculated, so no tax is paid on it.
- Gross income
- Your total earnings before any tax is taken out.
- Dependent care FSA
- A flexible spending account that lets you pay childcare costs with pre-tax money.
- Tax bracket
- The range of income taxed at a given rate; here, the 24% rate.
Transcript
- [Instructor] We're told that Luke and Jess are in the 24% tax bracket. They pay $250 per month for childcare. How much gross income do Luke and Jess need to earn per year to cover this expense with after-tax dollars? Pause this video and have a ago at that before we do it together.
Okay, so now let's do it together. I'll get a calculator out here. So $250 per month times 12 months is $3,000. Now this is what they're going to have to pay for the actual childcare, but if they're doing this with after-tax dollars, this is after tax. So we're taking 24% of something away.
And then when we take that 24% of that something away, of that pre-tax dollars, of that gross income, we're left with $3,000. Or another way to think about it is, if we have one minus 24%, that is 76%. So 76% of the gross income need to be equal to $3,000. So how do we figure out the gross income?
Well, we could divide by 76%. If we say $3,000 is 76% of what, we divide by 0.76, and we get, if we round to the nearest penny, $3,947, and, I just lost it, $3,947, $47 and 30, if I round to the nearest penny, 37 cents. Part two: How much would Luke and Jess save per year by using a pre-tax dependent care FSA instead?
Well, one way to think about this, if we're thinking about how much are they going to save per year, well, they're going to have to pay, if they're able to put it into a pre-tax FSA, they're not going to have to pay tax on that money. So one way to think about it is $3,000 is what they would be able to pay into it, and then that money is going to be deducted from their gross income for tax purposes, so they won't have to pay the 24% of taxes on this.
So we're gonna save... We are going to save $720, and we're done.
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