Uncle Sam has his ways of collecting your hard-earned money, but you may be able to keep a little more in your hands by paying for your health insurance with tax-free dollars. The best part is that you don't have to be a diplomat or work for the United Nations to take advantage of this perk.
Many employees can opt to pay their health insurance premium, or their portion of the employee-sponsored plan, using tax-free dollars. To do so, the employer must have a cafeteria plan -- also known as a section 125 plan -- that meets the requirements established by the Internal Revenue Service. This is the only way employers can allow their employees to choose to pay the health insurance premium tax-free -- so if your employer offers you the choice, she has a cafeteria plan.
How It Works
Not only do you not have to pay state and federal taxes on your health insurance premiums, you also don't need to pay Medicare tax or Social Security tax. Claiming a deduction for medical expenses at the end of the year, at most, saves you on state or federal taxes. Having the money taken out pre-tax means that you save an extra 7.65 percent -- 6.2 percent Social Security tax and 1.45 percent Medicare tax. Your rate is lower because your income is reduced by the amount of your health insurance premium and is never received by the employee, so it doesn't count as wages.
You can pay health insurance premiums for your spouse or dependents under this plan too. The expenses you pay with tax-free dollars cant also be claimed on your taxes as expenses. Schedule A on Form 1040 is used to claim a deduction for medical expenses that exceeded 7.5 percent of your adjusted gross income. While health insurance premiums are a valid deduction, you can't take the deduction if you already saved tax on this medical expense.
Since you save money because your salary is reduced by the amount of your health insurance premiums and is not considered wages, the amount will not be used to calculate your Social Security benefits when you retire. This could affect your benefit amount at retirement. The larger the amount you pay pre-tax, including for a spouse or dependents, the more likely it will have an impact on your benefit amount.
- TurboTax: Are My Health Insurance Premiums Deductible?
- Internal Revenue Service: Publication 502 - Medical and Dental Expenses
- Fox News - Business: Are Health Insurance Premiums Tax-Deductible?
- Social Security Online: Social Security & Medicare Tax Rates
- Internal Revenue Service: FAQs for Government Entities Regarding Cafeteria Plans
- Wayne State University: Pre-Tax Medical Insurance FAQ
Sara Mahuron specializes in adult/higher education, parenting, budget travel and personal finance. She earned an M.S. in adult/organizational learning and leadership, as well as an Ed.S. in educational leadership, both from the University of Idaho. Mahuron also holds a B.S. in psychology and a B.A. in international studies-business and economics.