Understanding Health And Life Insurance Tax Benefits

Health insurance and life insurance are both considered employee benefits, and the way they are taxed depends on the type of plan and how the employee chooses to pay for the premiums. Pre-tax deductions are taken from an employee's paycheck before any taxes are withheld, while post-tax deductions are taken from an employee's paycheck after taxes have already been deducted. Pre-tax deductions are generally preferred as they provide an immediate tax break, but they impact an employee's taxable income, whereas post-tax deductions don't provide immediate tax relief but won't be taxed when benefits are used in the future.

Pre-tax health insurance plans

With pre-tax health insurance plans, the employer deducts the health insurance premium from the employee's paycheck before withholding any income taxes or payroll taxes. This means that the employee's taxable income is reduced, resulting in lower tax payments.

There are several types of pre-tax health insurance plans, including:

• Section 125 cafeteria plans: These plans allow employees to choose between two or more benefits, such as dependent care assistance, accident and health benefits, and group-term life insurance coverage.
• Health savings accounts (HSA): HSAs are tax-free savings accounts that employees can use to pay for medical expenses. They are typically paired with a high deductible health plan (HDHP) and are owned by the employee, even if the employer contributes to the account.
• Flexible spending accounts (FSA): FSAs are similar to HSAs but are owned by the employer, and only employees can contribute to them.
• Health reimbursement arrangements (HRAs): HRAs allow employers to reimburse employees for medical costs, including insurance premiums, using non-taxable funds.

Post-tax health insurance plans

If you don't want to participate in your employer's pre-tax plan, or if your employer doesn't offer a pre-tax plan, you may be able to deduct your medical premiums on a post-tax basis. Unless you have one of the eligible healthcare spending accounts, any copays, prescription costs, and payments you make before meeting your deductible are also considered post-tax medical expenses.

Individually purchased plans with qualifying post-tax premiums include:

• Major medical coverage, such as purchasing individual health insurance through the Health Insurance Marketplace
• Supplemental/voluntary coverage, such as accident or disability insurance

You can drop coverage paid with post-tax dollars at any time. This flexibility is useful if you anticipate dropping the coverage and enrolling in another plan in the middle of the year because you qualify for a special enrollment period.

While different from pre-tax premiums, post-tax plans can still offer some savings. For example, you can still list premiums as an itemized deduction when you file your income taxes for all medical expenses and premiums that exceed 7.5% of your income. Additionally, most self-employed taxpayers (including business owners) can deduct health insurance premiums using Schedule 1 for Line 162 on Form 1040.

If you paid your premiums with pre-tax dollars, you don't qualify for this credit since you already received a tax break when your employer deducted your premium from your paycheck. The pre-tax option allows you to receive the full tax benefit because all your premiums are tax-free. Additionally, you can’t deduct your insurance premium if you're eligible for an employer-sponsored, pre-tax health plan and decline that coverage.

Pre-tax vs post-tax health insurance

Pre-tax and post-tax health insurance plans each have their pros and cons. This article will discuss the differences between the two and the impact of each on the overall tax burden of employees and employers.

Pre-tax Health Insurance Plans

Pre-tax health insurance plans are those where the premiums are deducted from an employee's paycheck before income taxes or payroll taxes are withheld. These plans are typically available for employer-sponsored health insurance and can save individuals up to 40% on income and payroll taxes. Common types of pre-tax employer-sponsored health plans include group health insurance, dental insurance, and vision insurance.

Pre-tax deductions lower the taxable income of employees, reducing the amount of federal income tax they have to pay. They also lower an employer's Federal Unemployment Tax (FUTA) and state unemployment insurance dues. However, employees might owe taxes in the future when they use the benefit, such as when they withdraw money from a pre-tax 401(k) plan upon retirement.

Post-tax Health Insurance Plans

Post-tax health insurance plans are an alternative option if an individual doesn't want to participate in their employer's pre-tax plan or if their employer doesn't offer one. Post-tax benefit contributions are taken from an employee's paycheck after taxes have already been deducted, resulting in higher income, payroll, and employment taxes for both the employer and the employee.

However, the employee typically won't owe any additional income tax on the benefits when they use them in the future, such as upon retirement. This can make post-tax deductions preferable for employees compared to pre-tax deductions.

Pre-tax health insurance is widely considered better for both employers and employees due to its tax benefits and the wider, more affordable health coverage it provides. However, it's important to note that not all employee health insurance plans are pre-tax, and it's essential to double-check with the insurance provider.

Additionally, there are specific cases, such as health insurance for owners of S-Corporations, where health insurance premiums are subject to taxes like regular wages. In such cases, it's crucial to ensure that no pre-tax deductions or contributions are made via payroll, and the cost of the premiums should be included in the taxable wage base.

Pre-tax benefits

There are various pre-tax benefits, including health insurance plans, health reimbursement arrangements (HRAs), and health savings accounts (HSAs).

Health Insurance Plans

Employer-sponsored health plans are a common pre-tax benefit, where the employer typically splits the cost of premiums with their employees on a pre-tax basis. This can include group health insurance plans, dental insurance plans, and vision insurance plans.

Health Reimbursement Arrangements (HRAs)

HRAs are employer-funded health reimbursement plans that help both employees and employers save on healthcare costs. Employers contribute pre-tax dollars for employees to pay for out-of-pocket medical expenses and sometimes individual health insurance premiums. As long as the employee's health insurance policy meets the minimum essential coverage (MEC), reimbursements are income tax-free.

Health Savings Accounts (HSAs)

HSAs are tax-advantaged accounts funded by both the employer and employee to pay for healthcare items. Employee contributions are made with pre-tax dollars, reducing their gross income. Withdrawals to pay for qualified medical purchases are also tax-free. Unlike flexible spending accounts (FSAs), employees keep their HSA funds even if they leave their job or become unemployed, and any investment growth is tax-free.

Other examples of pre-tax benefits include pre-tax retirement plans, such as traditional IRA plans, 403(b) plans, Thrift Savings Plans, and certain 401(k) plans. Additionally, pre-tax commuter benefits allow employees to deduct their monthly work-related commute costs, such as parking garage fees and transit passes, directly from their paycheck on a pre-tax basis.

It is important to note that not all pre-tax benefits are exempt from all federal tax withholdings. For example, while adoption assistance is exempt from federal income taxes, it is still subject to Social Security, Medicare, or FUTA tax. Similarly, pre-tax benefits may not be exempt from all state and local taxes, so employers should be aware of their specific state and local laws.

Post-tax benefits

For example, an employee who retires will not owe additional taxes when they withdraw money from a post-tax retirement plan. This can make a post-tax deduction preferable for employees compared to pre-tax deductions.

• Stipends: A stipend is a fixed sum of money offered to an employee in addition to their regular wages. Stipends can be provided on a regular basis, or as a one-time allowance or spot bonus. They allow employees to pay for various out-of-pocket expenses, such as wellness opportunities, professional development costs, fertility benefits, and remote office equipment. Stipends are considered taxable income, and employers must pay payroll taxes on stipend reimbursements. Employees are taxed between 20% to 40% on the total amount they receive as income at the end of the year.
• Post-tax retirement plans: A post-tax retirement contribution is when an employee contributes to a retirement account after income taxes have been deducted from their paycheck. The two types of post-tax retirement accounts are a Roth IRA and a 401(k). Roth contributions use post-tax money, and earnings can grow tax-free if held in the account for five or more years. Withdrawals are also tax-free. Roth IRAs are often preferable to traditional IRAs, which require taxes upon withdrawal. Certain 401(k) accounts also allow employees to make additional contributions after payroll taxes have been deducted from their wages. These contributions empower employees to invest more money in their retirement funds, providing them with tax-deferred growth until withdrawals begin.
• Disability insurance: Employees can choose to pay for disability insurance premiums with pre-tax or post-tax dollars. There are two types of disability insurance: short-term disability insurance, which usually covers employees' wages from three months to a year, and long-term disability insurance, which provides coverage for at least 90 days and can provide income replacement up to age 65. Long-term disability insurance premiums increase over time. It is typically preferred to pay disability insurance premiums post-tax, as this ensures that employees won't have to pay taxes on the benefits they receive in the future if they experience a disability.
• Life insurance: Life insurance premiums are tax-deductible as a business-related expense. The most common type of post-tax life insurance deduction is group-term life insurance. The Internal Revenue Service considers employer-provided group term life insurance tax-free if the policy's death benefit is less than $50,000. Coverage over $50,000 must be paid post-tax.
• Wage garnishments: Wage garnishments are a post-tax deduction, regardless of the reason. Examples include default student loans, child support payments, and court-ordered fines or restitution. Employers must send payments to the appropriate legislative authority or credit institution until the employee's debt is cleared.

Frequently asked questions