There are two primary advantage of pre-taxing payroll deductions for health insurance: payroll tax savings for your employer, and lower reportable W2 earnings lowers your tax bill in six ways.

Pre-taxing supplemental health insurance is not always the right choice to make. Learn about the savings potential alongside the consequence when you utilize the benefits – get payments returned directly to you.

Pre tax contributions is not available on every premium payment you may make:

  • Life Insurance
  • Critical Illness

Pre Tax Supplemental Insurance Deductions

Pre taxing supplemental insurance deductions is a big advantage of voluntary employee benefit programs. Pre tax deductions make sense in most instances except three: when claims payments may exceed out of pocket medical expenses, sometimes when insuring income, or when paying for policies making lump sum payments.

Supplemental health insurance makes cash payments directly to the insured, rather than directly to hospitals and doctors as do traditional health plans. When pre taxing deductions for supplemental insurance the claims payment becomes taxable; but only in the amount that exceeds your un-reimbursed medical expenses.

Pre Taxing Disability Income

Short term disability payments are reduced when the premium is paid pre tax. When purchasing short term disability it is best to pay the premium after tax if you expect to use the contract. This is common for women who are planning a pregnancy. These women are planning to use the policy, and the claims payment may greatly exceed the accumulated premium. It makes sense to pay levies on the smaller income (the premium) than on the larger (the claim amount).

Pre tax insurance deductions make great sense for most people. There is one very big exception. Women who plan to use disability insurance during maternity leave will have their claims payment reduced. Since the claims payments are likely to be much higher than the premium cost, the numbers work much better using an after tax deduction. Pay more in levies on the smaller premium.

Others who purchase short term disability income protection do so to guard against accidents or illnesses that might disrupt their ability to work. While paying using pretax elections their income is higher, and they may be in a higher bracket. Disability replaces only a portion of income, so while receiving claims payments they may be in a lower bracket. Pre taxing premium may make more sense in these scenarios.

Lump Sum Policies

Supplemental insurance policies that make lump sum payments, such as critical illness policies, are not eligible for pre tax elections. Pay for these policies after tax, and enjoy the full claims amount when you need it the most.

Pre Tax Life Insurance

Pre tax life insurance deductions do not comply with IRS guidelines. These contracts already have tax favored features. The death benefit is always paid in full to policyholder heirs without any IRS encumbrances. Life insurance policies that accumulate cash value grow free of any levies.

Pre Tax Advantages Vary by Income

Pre tax payroll deductions will generate different savings depending upon employee income. As income rises so does the marginal rate for federal and state income tax purposes – and thus so will the savings for both employees and employers.

FICA Tax Savings

But the FICA savings drop once an employee reaches an earning threshold. FICA (7.65%) funds both Social Security (6.2%) and Medicare (1.45%). Employees and employers make the same contribution based upon gross income.

Beginning in 2013 these rates are much higher. The FICA tax holiday ended beginning January 1 and employee contributions returned to historic levels. The Social Security component phases out at income above $113,700. There is no income limit on the Medicare contribution, but the rate jumps by .09% for individual gross income above $200,000. This incremental amount is paid by employees, and does not have to be matched by employers.

Before tax deductions are a helpful way to cut your bill and put extra money in your pocket rather than the government’s. In addition to your health insurance deductions you can make pre tax contributions to a 401K, and a flexible spending account to lower your medical expenses, and for child care. There are six different ways a lower W2 income saves you money.

Payroll Savings for Employers

Employers cut payroll taxes. Two parties save money when an employee elects to make a before tax deduction at work. The employee lowers his or her W2 earnings which can lower the amount paid in six different ways, including FICA taxation. The burden of funding FICA falls on both the employee and employer. The employer sees this as a payroll expense, and lower payroll translates into lower payroll assessments.

Health Insurance Deduction Savings Example

Pre tax health insurance deductions save money. Since claims on major medical plans are paid directly to hospitals, doctors and other health care providers there is no consequence when you use the policy. Pre tax deductions are one of several ways to lower employee health insurance average costs. Let’s look at a simple example:

After-Tax  Pre-Tax
Gross Pay $1,000.00 $1,000.00
Pre-Tax Deduction $0.00 $100.00
Gross Income $1,000.00 $900.00
Federal Levy - 25% $250.00 $225.00
State Levy - 5% $50.00 $45.00
FICA Levy - 7.65% $76.50 $68.85
Net Income $623.50 $661.15

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