Premium Conversion

A pretax health insurance plan allows you to pay your premiums with before-tax money; your contributions are taken out of your paychecks before taxes are calculated. This results in a reduction of your taxable wages.

Premiums paid toward a Section 125 health plan are excluded from federal income tax, Social Security tax and Medicare tax. For example, you earn $1,300 biweekly and pay $100 total toward your pretax family health plan. You would subtract $100 from $1,300 to get $1,200, which would be subject to taxation.

When you pay your medical premiums with pretax money, you get a tax break because your payment is deducted before taxes are withheld from your paycheck. When you pay with after-tax money, you don’t get a tax break, because your premiums are deducted after taxes are withheld.

Pretax Plan

To pay your medical premiums with pretax money, you must be enrolled in your employer-sponsored health insurance plan. To offer its employees pretax health insurance, your employer must establish a plan that meets the requirements of Section 125 of the Internal Revenue Code.

After-Tax Election

If you do not want to participate in your employer’s pretax plan, you may elect to have your medical premiums deducted on an after-tax basis.

Pretax Exclusions

Pretax medical premiums are excluded from federal income tax, Social Security tax, Medicare tax and usually state and local income tax. Check with your state revenue agency for clarification on whether Section 125 premiums are excluded from state and local income tax, as the state may have specific conditions.

Effect

With a pretax plan, your employer deducts your premiums from your gross wages before calculating taxes. This process reduces your taxable income and results in more take-home pay than if you paid with after-tax money. After-tax premiums do not reduce your taxable income.

Tax Deduction

If you pay your medical premiums with after-tax money, you may deduct your premiums as a medical expense on Schedule A when you file your tax return with the IRS. Before you can get this tax benefit, your total medical premiums must be more than 7.5 percent of your income. If you paid your premiums with pretax money, you do not qualify for this tax credit since you already received a tax break when your employer deducted the premiums from your paycheck. The pretax option allows you to receive the full tax benefit because all of your premiums are tax free.