If you are thinking of offering group insurance or a HRA to your employees, or if you are already offering them one or both, you might be wondering how to withhold employee insurance premiums and your contributions from their paycheck. Do the deductions come out of their paycheck pre-tax or after-tax? In some cases, you can deduct their premium and your contributions from their paychecks pre-tax; other premiums may need to be deducted after-tax. It is important to know what kinds of contributions can be deducted pre-tax, as well as the advantage and disadvantages of doing so.
Taking a pre-tax deduction means that you, the employer, withdraw money directly from your employees’ paychecks to cover the cost of benefits before income or payroll taxes are withheld. Internal Revenue Code (IRC) Section 125 allows for payroll deductions to be taken pre-tax for certain benefits, including:
- Major medical coverage
- Dental and vision insurance
- Some retirement plans, such as 401(k) plans
- Accident insurance
- Cancer insurance
- Healthcare Spending Accounts (HSAs)
- Flexible Spending Accounts (FSAs)
In order to know which pre-tax benefits are exempt from state and local taxes, you will have to check your state and local laws.
What is the advantage of deducting premiums and contributions from your employees’ paychecks pre-tax? For employees, when premiums and contributions are deducted pre-tax, the amount of income that they have to pay taxes on is reduced, in some cases by up to 40%.
Doing this not only benefits your employees, it also benefits you; pre-tax deductions lower your tax liability, including the Federal Unemployment Tax (FUCA), State Unemployment Insurance (SUI) and FICA. For every dollar contributed to a retirement account, FSA or insurance plan, an employee’s taxable income is decreased accordingly. Your employees’ paychecks will effectively be lowered, meaning you will pay less in payroll taxes.
The drawback is that your employee might owe taxes on the money you withheld in the future. This is because they did not pay any federal, state, and local taxes on the contributions at the time they were withheld. These taxes were simply deferred. For example, when your employee retires and begins drawing on their 401(k), they will owe taxes on the money they use from their pre-taxed 401(k) plan.
After-tax premiums and contributions are deducted from your employees’ paychecks after income and payroll taxes are deducted. Unlike pre-tax deductions, these will not affect your employee’s taxable income. However, you and your employee will owe more payroll taxes with after-tax deductions. If premiums are deducted after-tax, your employees will not pay taxes when using the benefits in the future, such as when they withdraw money from a post-tax retirement or health arrangement plan. Common after-tax premiums include:
- Some retirement plans (such as a Roth 401(k) plan)
- Disability insurance
- Life insurance
- Major medical coverage purchased by an employee on their own
If you need help finding group insurance, a HSA, FSA, or HRA, then EZ.Insure can help. We want to make sure that you save as much money as possible, which is why we compare all plans in your area, for free. We will assess your business’ and employees’ needs and find the best plan that will help cut costs, not coverage. If you need help figuring out which plans qualify for pre-tax and post-tax deductions, we can help with that too. We will answer your questions and guide you through the process. To start comparing plans for free, simply enter your zip code on the bar above, or to speak directly with an agent, call 888-998-2027.