( by Stephen Weru )
One of the most common questions we receive from CFOs and employers looking to buy health insurance for employees is, “Do I withhold premiums before or after-tax, and Do I get a choice on whether to withhold premiums pre- or post-taxation?”
If you provide healthcare benefits to your employees, you’ve probably had a similar question at one time.
Today we answer these questions.
But before that, let’s start with some definitions.
What are Pre-Tax Medical Premiums?
When paying for employee health insurance, do you deduct premiums from their pay before or after withholding taxes?
Like most organizations, it’s usually before withholding taxes. Right?
This is what pre-tax medical premiums are. With pre-tax medical premiums, deductions are made before calculating taxes, which in turn reduces your employee’s taxable income.
Pre-tax medical premiums allow your employees to enjoy a tax break, which in some instances may deliver savings of between 25% and 40%.
And it’s not only your employees who benefit.
Once you set up an employer-sponsored health insurance plan that meets the Cafeteria plan’s requirements (Section 125 of the Internal Revenue Code), you become eligible for several tax breaks.
For starters, you’ll get to save on FICA withholding tax. Some states also offer tax credits to employers who’ve recently established a medical insurance plan under the cafeteria plan.
What are After-Tax Medical Premiums?
Maybe some of your employees don’t want to participate in your group health insurance plan. They prefer coverage from a provider in the open market. Such employees can choose to have their health insurance premiums deducted after taxes are withheld.
This is where after-tax medical premiums come in. In most instances, after-tax medical premiums are applicable for individual health insurance coverage bought through the health insurance marketplaces.
However, since premiums are paid after-tax, your employee doesn’t benefit from tax breaks; therefore, no savings.
On the upside, after-tax medical premiums allow your employees the freedom to enroll or drop coverage at any time of the year—no need to wait for enrollment periods.
Employees who elect to have an after-tax plan can also enjoy tax credits. When filing tax returns with the IRS, your employees can choose to deduct premiums as an itemized deduction under Schedule A. To qualify for a tax break under this rule, your employees’ health insurance premiums need to be more than 7.5% of their income.
As an employer, you can also choose an after-tax plan, where you deduct health insurance premiums using Schedule 1, line 16 of the IRS taxation form 1040.
There’s a Third Option: Create a Health Reimbursement Arrangement
If you can’t offer your employees a traditional group insurance cover for some reason but still want to provide health benefits on a pre-tax basis, you can create a health reimbursement arrangement (HRA).
With a HRA, employees purchase health insurance cover using an after-tax plan. You then reimburse these employees for premiums on a pre-tax basis.
Talk about a win-win situation.
You still get the tax breaks that would come with a pre-tax option and have more control over how much you spend on employee health.
We hope this article has shed some light on the pre-tax vs. after-tax medical premiums debate. Now you can make the best choice on when to withhold health insurance premiums.
If you’re still not sure of the best approach, contact an insurance broker to help you. And who other than Zupnick & Associates.
With more than a decade of experience in the insurance marketplace, our team of brokers will help you with any insurance question you have, and in turn, allow you to decide on whether to offer pre-tax or after-tax benefits.