125 Employee Choices

Forgive me all you experts as this topic is new to me. We have a written 125 document that runs calendar year. All of our health and dental premiums are pre-tax. Do I understand that I must offer an after-tax option for employees as well?

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  • I'm somewhat confused, but I'll try and answer.

    The only way your health and dental premiums can be deducted pre-tax is if they are "ran through" a Section 125 plan. Which appearently you are doing. An employee could chose not to participate in the Section 125 plan, thereby making his/her deductions after tax.

    I'm not sure why an employee would not want to take advantage of the pre-tax deduction, but I suppose, if he/she wanted to they could decline to participate in the the Section 125 enrollment.
  • That's a fair and logical question.

    Remember that all of our social security contributions are based on our earned wages, so if I pay $10 , my employer is required by law to match $10. By reducing my income, which is what a pre tax plan does, I have less going into may social security account and less of a match from my employer. Consequently when I retire I would not be eligible for less social security although the amount is extremely small in the majority of cases.

  • Participating in the cafeteria plan also restricts the member from making changes to their enrollment elections to insurance plans willy nilly.
  • What you are asking about relates to what’s known as a premium conversion plan also known as a premium only plan (POP). Some plans are structured so that the employee's premium, medical in your case, is required to be taken out on a pre tax basis and thus no employee offering of an after tax is required. However, since reduction in taxable wages also results in a reduction in social security benefits (albeit usually a small amount) since social security payments by the employee and employer are based on income. For this reason, I would think you would want to offer the employee the option of continuing to pay premiums with after tax dollars. Employees could complain that you have not allowed them to contribute as much to social security as they wish and that they would also be losing the portion matched by the employer.

    As I stated above the benefit to the employer is that is does reduce your employer’s tax liability since the employer is not paying as much in social security match monies.

  • Your reply was most helpful. I guess the question I am most concerned about is this: does a company who sets up a 125 plan legally have to offer an after-tax option?

    The 125 plan keeps participants from dropping and adding except at open enrollment (of life event.
  • Let's also throw into the mix the fact that this reduces taxable income. This is often the bigger component for EEs. Not only would they not have to pay social security, they do not have to pay Federal (or state) Income Tax on these amounts. If you know your tax brackets, you can quickly find the additional savings.

    In our shop, they do not get a choice of pre or post tax. We only allow most of our voluntary payroll tax deductions to be pre-tax through the cafeteria plan, with one exception, and those are the disability premiums. We do that because the benefits received are taxable if you run the premiums through the 125 plan, but they are not taxable if you pay those premiums with after tax dollars.


  • Same for us....we only offer the pre-tax deductions.
  • Your questions are governed by the IRS code. I have listed the IRS's response to the question you asked, that is listed in the IRS code. POP (Premium Only Plans), which I mentioned in an earlier response is what you are describing. The IRS says:

    (1) In general
    The term “cafeteria plan” means a written plan under which—
    (A) All participants are employees, and
    (B) the participants may choose among 2 or more benefits consisting of cash and qualified benefits.

    The important point is item (B) in that the term “cash” from the IRS perspective (at least for this purpose) is the same thing as providing an after tax option. So you have to provide an after tax option AND the term “qualified benefits” is an employee benefit that receives tax-favored benefits from you as an employer, i.e. you pay medical premiums before taxes are taken out, SO you also have to provide the pretax option.

    You can do this a couple of ways. (1) You can actually put this on the form the employee signs to allow the employee to say they want their premium paid with after tax dollars. (2) You can also, and (this is what I prefer) state in your plan document that you will withhold all employees premium for medical insurance on a pre tax basis unless you (the employee) informs the company otherwise. Frankly, rarely will an employee come to you on this basis.

    So, the answer to your question is YES you must provide them the option to pay on an after tax basis, but this can easily be accomplished by including a statement similar to what I said above in your plan document. You can then include it in your SPD (summary plan description) if you provide this to them.

    I am not a lawyer, just a long time HR person who has some experience, so before doing anything I would recommend you reconcile my comments with your lawyers view.

    I hope this helps. Here's the IRS link if you wish to look at it yourself. Scroll down to item (D) Won't it be great if the IRS made things simple. :)

    [url]http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00000125----000-.html[/url]

  • I asked our insurance agent and was told we had to provide EEs the option of paying their premiums on an after-tax basis. They didn't give me the legalese to back it up, unfortunately.

    I do know that one of the biggest reasons an EE would opt to go after-tax is that if you do a true Section 125 plan, EEs are locked into that agreement for the plan year. In other words, they can't just drop/change insurance coverage at any time barring one of the qualifying events. If an EE thinks they may want to eventually get on their spouse's plan (without a qualifying event) the only way they could switch plans is by having the post-tax option on their own 125. We have a few EEs that choose this each year as it affords them more options.

    Hope that made sense - my noggin's not working too clearly today!
  • As NeedCoffee says (what an original username!) you do have to provide both, but remember this can be done on the form the employee signs by offering the two options or included in you plan description as done on pretax by default unless the employee notifies otherwise. You can also avoid having an annual signing by employees by making it evergreen unless the employee tells you otherwise. Of course that would also need to be part of the plan document and SPD.
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