Jane Dotson
Offering your employees pre-tax medical insurance can be a great way to attract and retain talent. It is also one of the largest expenses that employers and employees have to budget for each month. There are a few ways to go about this. Firstly, you can deduct the employee-paid portion of the insurance premiums before withholding any taxes. This is known as a pre-tax deduction and can include health insurance, group-term life insurance, and retirement plans. Secondly, you can set up a premium-only plan (POP) or a Section 125 cafeteria plan, which allows you to deduct insurance premium contributions from your payroll on a pre-tax basis. Lastly, you can offer a health reimbursement arrangement (HRA) that allows employees to have pre-tax benefits while paying for their premiums with post-tax dollars.
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What You'll Learn
Pre-tax health insurance plans
Offering pre-tax health insurance plans to employees can be a great way to improve retention and attract new talent. It is also one of the largest expenses for employers and employees to budget for each month. Thus, it is important to understand how pre-tax health insurance plans work.
There are several types of pre-tax health insurance plans that employers can offer. One common type is a Section 125 cafeteria plan, which is a written plan maintained by employers where all participants are employees, and participants can choose between two or more benefits. The benefits consist of cash and qualified benefits and are not includible in gross income. Another type of pre-tax health insurance plan is a Health Reimbursement Arrangement (HRA), which allows employees to have pre-tax benefits even as they pay for their premiums with post-tax dollars. With HRAs, employees can choose the health plan they want or need. A third type of pre-tax health insurance plan is a Premium-Only Plan (POP), which allows employers to deduct insurance premium contributions from their employees' payroll on a pre-tax basis.
Employers can also contribute to their employees' Health Savings Accounts (HSAs), which are similar to Flexible Spending Accounts (FSAs). However, unlike FSAs, employees have total ownership of their HSAs, and they can leave the company and take their HSA funds with them. For 2025, individuals can contribute up to $4,300 each year for self-only coverage and $8,550 per year for family coverage.
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Health reimbursement arrangements (HRAs)
There are a few different types of HRAs:
- Individual Coverage HRA: This is a new type of HRA that employers can offer as an alternative to traditional group health plan coverage. Employees can use it to reimburse premiums for individual health insurance, promoting flexibility while maintaining the same tax-favored status for employer contributions.
- Qualified Small Employer HRA (QSEHRA): This is available for small employers who are not required to purchase company health insurance under the Affordable Care Act (ACA). A small employer under the ACA has fewer than 50 full-time equivalent (FTE) employees.
- Excepted Benefit HRA: This allows employers to finance additional medical care, even if the employee declines enrollment in the traditional group health plan.
With HRAs, employees can enjoy pre-tax benefits while paying for their premiums with post-tax dollars. This is because employers can reimburse employees for medical costs, including payments on premiums, using non-taxable funds. This results in a smaller tax burden for employees.
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Section 125 cafeteria plans
A Section 125 cafeteria plan is a cost-effective way for businesses to offer employees, their spouses, and dependents certain benefits on a pretax basis, thereby lowering the employee's taxable income. It is a written plan maintained by employers where all participants are employees, and participants can choose between two or more benefits. The benefits consist of cash and qualified benefits and are not includible in gross income.
A Section 125 plan is pre-tax, so before withholding any taxes, deduct the employee-paid portion of the insurance premiums. For example, if you purchase a Section 125 cafeteria plan for your employees with premiums of $600, and you pay 50% of the premiums, you deduct $300 from your employees' paychecks and contribute $300 to the premiums.
The benefits that qualify under Section 125 include health insurance premiums, health flexible spending accounts (FSAs), health savings accounts (HSAs), and dependent care assistance programs (DCAPs). These deductions not only decrease the employee's taxable income but also reduce the employer's payroll tax liabilities.
To set up a Section 125 benefits plan, employers have to draft a document that outlines the benefits offered, contribution limits, participation rules, and other information required by the IRS. They may also have to perform non-discrimination tests, depending on the plan, to ensure it does not favor highly compensated or key employees.
Cafeteria plans can help employers attract and retain talent as employees today place great emphasis on having access to flexible benefits that improve their well-being and that of their families.
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Health savings accounts (HSAs)
The funds in an HSA can be used to pay for both near-term medical expenses and expenses in retirement. The money in the account is not taxed, even if it earns interest or investment returns. This makes it "tax-advantaged". HSAs are also not subject to "use-it-or-lose-it" rules, meaning that employees can carry forward their savings until they want or need to use the money. This, combined with the ability to invest funds, allows health savings to benefit from compounding returns.
Employers can contribute to their employees' HSAs, but the employee has total ownership. This means that if an employee leaves the company, they can take their HSA funds with them. For 2025, individuals can contribute up to $4,300 each year for self-only coverage and $8,550 per year for family coverage. Employees can roll over funds to the following year, and these rollover funds do not count toward that year's maximum contribution.
By using pre-tax dollars, employees can benefit from a smaller tax burden. This is because contributions reduce the taxable income. HSAs are, therefore, a useful way for employers to help their employees save money on health insurance.
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After-tax medical premiums
Unless you have one of the eligible healthcare spending accounts, any copays, prescription costs, and payments made before meeting your deductible are also considered after-tax medical expenses.
Individually purchased plans with qualifying after-tax premiums include major medical coverage, such as purchasing individual health insurance through the Health Insurance Marketplace, and supplemental/voluntary coverage, such as accident or disability insurance.
You can drop coverage paid with after-tax dollars at any time, so this route is a good option 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, after-tax plans can still offer some savings. For example, you can 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 can deduct health insurance premiums using Schedule 1 for Line 162 on Form 1040.
If you get insurance in the Health Insurance Marketplace, you can deduct the full cost of your health care premiums from your taxable income, even if you don't itemize your taxes. However, if you can get health coverage through a spouse's plan but choose to go through the Health Insurance Marketplace instead, you are not allowed to deduct the premiums from your taxable income.
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Frequently asked questions
Pre-tax medical insurance can save employees up to 40% on income and payroll taxes. It also reduces the base salary used to calculate unemployment compensation.
A cafeteria plan is a written plan maintained by employers that permits eligible employees to choose between two or more benefits consisting of cash and qualified benefits. These benefits are not includible in gross income.
Examples of pre-tax deductions include health insurance, group-term life insurance, retirement plans, and dental and vision coverage.
A Health Reimbursement Arrangement (HRA) allows employees to have pre-tax benefits while paying for their premiums with post-tax dollars. An employer can reimburse employees for medical costs, including payments on premiums, using nontaxable funds.
It is important to note that not all employee health insurance plans are pre-tax, so it is essential to double-check with your provider. Additionally, employers must adopt a written cafeteria plan to permit employees to pay for certain eligible benefits with pre-tax dollars.
