Supplemental insurance policies continue to gain traction as a popular approach to creating more robust benefits packages. Employers should know how these benefits are treated for taxation purposes, and how they can benefit from offering them, as well. 

Supplemental insurance plan premiums may be paid in one of several ways. They may be:

• Employee-funded with pre-tax earnings for qualified Section 125 Cafeteria plans

• Employee-funded with post-tax wages

• Employer-funded

• Jointly funded by both employee and employer

Each approach has its benefits and drawbacks, and employers should consider both the long-term and short-term impact of each method before implementing a new supplemental insurance option.

Funding Supplemental Insurance With Employee Pre-Tax Earnings

Under IRS Code Section 125, some supplemental insurance policies may be eligible for deduction from an employee’s wages on a pre-tax basis. A qualified cafeteria plan may include benefits such as adoption assistance, dependent care, group term life insurance, health savings accounts, and accident and health benefits.

Several popular supplemental insurance options fall under the umbrella of accident and health, including:

• Critical Illness

• Cancer

• Accident

• Dental

• Vision

• Disability

It’s important to note that each policy is different, and only your supplemental insurance provider can tell you whether your policy qualifies for inclusion under a Section 125 Cafeteria plan.

When employee contributions are made via pre-tax deductions, the tax liability for the employer is also reduced for FICA, and may also reduce FUTA liability, as well. As a result, many employers and employees view pre-tax deductions as having the most significant impact to their overall tax liability. However, there is good reason to consider both the short term and long term benefits when deciding how these plans will be funded.

Many supplemental insurance policies are designed to pay employees a lump sum or incremental payments when they file a claim for a qualifying event. If an employee pays 100% of their premium costs for a qualified plan with pre-tax deductions, payments they receive after filing a claim will result in a tax liability. While employees may appreciate the reduced tax liability as a result of their pre-tax premium deductions from each paycheck, they may not realize that they could incur a tax liability in the future as a result.

For example, an employee who will be out of work for six weeks due to a qualifying disability will receive payments from their disability plan equal to a portion of their previous salary. If their premiums were paid with pre-tax deductions, they will need to reconcile the tax liability when filing their annual return if taxes were not deducted from the payments.

Employee-funded with Post-Tax Wages

When an employee contributes to their premium payments with post-tax earnings, the employee will not incur a taxable event when they receive lump sum benefits from these policies.

Both the employee and the employer will pay taxes on the employee’s gross wages each pay period, after which deductions are taken from the employee’s net pay and sent to the supplemental insurance provider to pay the premiums.

Supplemental Insurance Policies Funded 100% by Employers

To ensure that employees are not surprised by a taxable event when filing a claim on their supplemental insurance policies, many employers opt to fund these in whole or part for their employees.

When an employer pays for the costs of their employees’ accident or health insurance, the premium costs are not considered wages and are therefore not subject to FICA, FUTA, or Federal Income Tax (exceptions apply for employees of S corporations who are shareholders owning 2% or more of the corporation.)  

As with any new benefit, employers should review their options with their accountant and benefits administrator but, generally, 100% of the premium cost is deductible to the business when the employer funds it 100%.

Jointly Funded Supplemental Insurance Policies

Many employers pay the cost of the supplemental insurance premiums for their employees and extend the option to add coverage for spouses and dependents through payroll deductions. For example:

An employer pays for an Accident insurance policy for all of her employees. The plan includes automatic coverage for qualified dependents, and employees may opt to extend coverage to their spouses through payroll deductions.

The employer’s premium cost for their five employees is $200 per month.

Two employees opt to have post-tax deductions taken from each paycheck to cover their spouses totaling $25 each per month.  

Both employees will pay taxes on their portion of the post-tax premium deductions. The employer will also be responsible for FUTA (Federal Unemployment) if the limit has not been met and the employer portion of Social Security and Medicare.

The employer will send a $250 payment to the benefits provider each month, $200 of which (the employer-paid premiums) will be deductible to the business.

Partner with Accuchex to offer maternity coverage and other supplemental insurance plans to your employees

Navigating the ever-evolving tax code can be a significant undertaking for even the most seasoned small business owner. To ensure that you’re in compliance, abreast of changes, and getting the most value out of your benefits, it’s important to consult with your attorney, accountant, and other advisors before making changes to your benefits plan.