• Buying individual health insurance policies with pre-tax dollars

    I learned something important from a recent paper in Inquiry by Mark Hall and Amy Monahan, “Paying for Individual Health Insurance Through Tax-Sheltered Cafeteria Plans.” In some states it is possible to purchase health insurance policies on the individual market with pre-tax dollars, thus benefiting from a privilege I thought only available to purchasers of employer-sponsored plans. This is a big deal, as I’ll explain below. First, the abstract:

    When employees without group health insurance buy individual coverage, they do so using after-tax income—costing them from 20% to 50% more than others pay for equivalent coverage. Prior to the passage of the Patient Protection and Affordable Care Act (PPACA), several states promoted a potential solution that would allow employees to buy individual insurance through tax-sheltered payroll deduction. This technical but creative approach would allow insurers to combine what is known as “list-billing” with a Section 125 “cafeteria plan.” However, these state-level reform attempts have failed to gain significant traction because state small-group reform laws and federal restrictions on medical underwriting cloud the legality of tax-sheltered list-billing. Several authorities have taken the position that insurance paid for through a cafeteria plan must meet the nondiscrimination requirements of the Health Insurance Portability and Accountability Act with respect to eligibility, premiums, and benefits. The recently enacted Patient Protection and Affordable Care Act addresses some of the legal uncertainty in this area, but much remains. For health reform to have its greatest effect, federal regulators must clarify whether individual health insurance can be purchased on a pre-tax basis through a cafeteria plan.

    Are you getting this? Let me make it clear. The PPACA may make it possible for workers to get the same tax break for purchasing health insurance on the individual market (via an exchange or otherwise) as they would if they bought their employer-sponsored plan (if they’re offered one). If this is the case, it removes one huge incentive for maintaining employer-sponsored coverage. With respect to taxation, it levels the playing field between the group and non-group (individual) markets.

    There’s still the issue that until 2017 only employees of firms with fewer than 100 workers are eligible for exchange coverage. Beginning in 2017, states can open exchanges to employees of larger firms. Workers of firms of any size could buy coverage on the individual market that is outside the exchange, they just can’t obtain federal subsidies for them. Still, it’s the tax subsidy that makes employer-based coverage so valuable to workers. If it can be applied in the non-group market it would hasten the erosion of employer-based coverage (which is not a bad thing, necessarily).

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    • Cafeteria Plans. can be rather complicated for very small employers to set up and maintain.

      • @Floccina – I’m interested in knowing more. Can you elaborate or point to something that documents the complexity? Are cafeteria plans more trouble than setting up some other group plan? If an employer wants to provide tax-free health benefits, what’s the simplest approach? How much simpler is it?

    • I didn’t read the paper. I also would like to point out, as Floccina did, a Section 125 cafeteria plan has to be created and maintained by an employer in the first place. It’s not like any employee can just go out and buy individual health insurance and take a tax deduction.

      If this works at all, the employer will first have to establish a Section 125 cafeteria plan, collect money from the employees through payroll deduction, then pay the insurance premiums from the plan. At that point, the employer might as well buy a group policy on an unsubsidized basis, i.e. have the employees pay 100% of the premium on the group policy.

      Don’t get your hopes too high.

    • As one who creates and helps employers maintain 125 plans, they are actually quite simple with rather basic rules (no opt-in outside of open season without a life changing event, no opt-out without a life changing event , pre-tax dollars).

      I would love to see the 7.5% floor of AGI for medical expenses done away with for the purchase of insurance. That would definitely help level the playing field, and actually be a benefit to younger people not in a group plan. Most people do not realize that a young person can actually save over the cost of a voluntary group plan (one with no employer contribution) because of the group plan’s use of average age and prior claim history to price the policy. I have seen a young person actually save as much as $100-$150/mo over an employer sponsored, voluntary plan.

      @Austin – it’s simple to set up a plan, there’s a plan outline document showing plan dates (year start-end), who the administrators are, and who is eligible. Most of the language is boilerplate legalese.

      Here’s an example – https://www.mahealthconnector.org/portal/binary/com.epicentric.contentmanagement.servlet.ContentDeliveryServlet/FindInsurance/Section%252520125%252520Handbook%252520documents/Section%252520125%252520-%252520plan%252520document.doc

      The actual administration is quite simple.

    • The PPCA specifically does not allow this.

      Sec. 1515 amends the tax code to say that plans provided through the exchange will not be an eligible benefit under an employer-sponsored cafeteria plan, except in the case of qualified employers (i.e. small employers, and, after 2017, large employers in electing states) offering a choice of plans to their employees through the exchange.

      If this was allowed, it would erode job-base coverage, for the reasons each of you note. Part of the concern would be the increased costs on the federal government for exchange subsidies.

    • The benefits of group underwriting in an employer plan dwarf the tax benefits.

    • LLC’ an individual limited liability corporation allowing medical tax deduction

    • Hi, great post! Thanks..

    • It is fundamentally unfair for a person to have to use after tax dollars for a service just because they choose or have to be self employed versus working for a large employer. I write this as I benefit from the break as I do happen to work at a large employer, but I recognize that congress gives me that break on the backs of others who work elsewhere (for example my brother).
      This is unfair, and likely unconstitutional, of course no single person has the resources to fight this in court.
      The President who talks about fairness all the time and being all in it together, perpetuates this with his law, and ridiculed McCain when he proposed a 5000 credit for all taxpayers, which may have been less than some get, but was certainly fair.

    • Self-Employed individuals are not legally allowed to pay for their individual insurance premiums with pre-tax dollars. Their premiums are also higher and they do not qualify for a Cafeteria plan. This is not due to a lack of an employer option. This is due to choosing to be their own boss, negotiating their own contracts and actually having a good income with no employees.

      Self-employed pay their taxes without the tax benefits in obtaining health insurance for their families.

      • Cathy (and others):

        Aren’t self-employed medical premiums deductible on line 29 of the 1040? That makes them deductible – just in a different place – but should net out roughly the same. Thoughts?

        • The difference is that the self-employed health insurance does not reduce the self-employment tax (social security & medicare taxes); the adjustment only reduces income taxes. The pretax employer-provided coverage reduces both the employer and employee social security and medicare taxes, so the tax treatment is NOT equal. Eliminating employer-provided coverage can be a boondoggle to the social security and medicare systems.