Payroll Deductions for Health Insurance
Pretax health insurance plans provide both employees and employers with a tax break, so it’s practical for an employer to establish one. If you participate in your employer’s pretax health plan, you pay your premiums with pretax money via payroll deduction. You can pay your premiums by payroll deduction on a post-tax basis with after-tax money instead.
Under the Affordable Care Act, starting in 2014, employers that offer health insurance and have at least 50 full-time employees must provide a comprehensive plan that pays no less than 60 percent of the health care costs. The plan must also be affordable, costing below 9.5 percent of an employee’s income.
To pay premiums for prescription drug coverage and for medical, dental and vision insurance on a pretax basis, you must participate in your employer’s Section 125 plan, commonly called a "cafeteria plan." In some states, employers that offer health insurance must do so under a cafeteria plan. If a cafeteria plan is not required, the state might encourage employers to establish one by offering them a tax credit.
Pretax Versus After-Tax
The key difference between paying for health insurance with pretax money and after-tax money is that the former is taken out of your wages before taxes are withheld, and the latter is taken out afterward. If your plan is pretax, you do not pay federal income tax, Social Security tax, Medicare tax, and, depending on your state, state income tax on your premiums. Your employer gets a tax break on its portion of Social Security and Medicare taxes.
Unless you have a qualifying event, such as marriage, birth or divorce, you generally cannot make changes to a pretax health insurance plan until open enrollment, which happens once during the plan year. For example, to change your plan from "preferred provider organization" to "health maintenance organization," or from individual to family, or to cancel the plan entirely, you must wait until open enrollment. If you pay for coverage with after-tax money, you can generally make changes at any time.
Paid Versus Paid Leave
If you go on paid leave, your payroll deductions for health insurance may continue through the end of the year, and your employer will continue to submit your payments to the carrier. To continue pretax deductions for the next year, you may re-enroll during open enrollment. If you go on unpaid leave, your payroll deductions will cease. If you want to continue your coverage, you may pay the premiums yourself with after-tax money.
Tax Filing Deductions
If you paid qualified medical and dental costs for yourself, your spouse or your dependents, you may be able to claim them on your federal, and, if applicable, state tax return. Under IRS rules, you can claim only the amount by which your total costs are more than 7.5 percent of your adjusted gross income. Unlike the expenses you claim on your tax return, a Section 125 pretax plan gives you a tax break on all your health insurance premiums. You may not claim a deduction for pretax premiums on your tax return since you already received a tax break through payroll deduction.
- Upstate Medical University: Health Insurance Frequently Asked Questions (FAQs)
- University of California, Berkeley: Affordable Care Act
- National Conference of State Legislatures: States' Use of "Cafeteria Plans" to Provide Health Insurance
- Clackamas Community College: Section 125 Plan
- IRS.gov: Medical and Dental Expenses
Grace Ferguson has been writing professionally since 2009. With 10 years of experience in employee benefits and payroll administration, Ferguson has written extensively on topics relating to employment and finance. A research writer as well, she has been published in The Sage Encyclopedia and Mission Bell Media.