Tax Advantages of Pre-Tax Health Insurance

The Internal Revenue Service allows employers to offer three types of plans related to health insurance that can be paid with pre-tax dollars. The difference between pre-tax dollars and post-tax dollars is that if you pay for your insurance pre-tax, the amount you pay reduces your income by that amount and reduces your tax liability accordingly. The three plans related to health insurance are cafeteria plans, flexible spending plans and health savings accounts.

Flexible Spending Plans

Flexible Spending Arrangements, or FSA, allow you to set aside a pre-determined amount of money at the beginning of the year that you can use to pay health-care related costs, such as insurance deductibles and co-pays. The pre-determined amount of your contribution to the FSA is made through a salary reduction arrangement with your employer. The money you put aside is not subject to income or employment taxes, such as Social Security and Medicare.

Health Savings Accounts

A Health Savings Account, or HSA, is a plan that involves your employer making contributions to the account that are not included in your gross income. You can make contributions and your employer can make contributions, but the total of the two cannot exceed the contribution limit of that tax year. Contributions must be made in cash, not stocks or property. If your health insurance only covers you, the 2010 maximum contribution is $3,050 -- $6,150 for family coverage. If you are 55 or older you can contribute an additional $1,000.

Cafeteria Plans

A Cafeteria Plan is a written plan offered by employers to their employees that allows you to pay for your health insurance before taxes are taken out, which reduces the amount of your wages that are subject to taxes. This reduces your tax liability and thereby increases your take-home pay. You can also choose a taxable benefit, such as cash. These plans are also known as section 125 plans. The contributions are made through a salary reduction agreement with your employer for a specified amount.

Restrictions

Each of these plans has their own restrictions. You can only qualify for a HSA if you have insurance offered by your employer that has a minimum annual deductible of $1,200, or $2,400 for family coverage, and a maximum annual deductible and out-of-pocket expenses limit of $5,950, or $11,900 for family coverage. A FSA has no limit to the amount that can be contributed from an IRS perspective, but you cannot exceed the limit set by your employer. The caveat to a FSA is that whatever money you contribute that you don't use is forfeited at the end of the year. Under a Cafeteria Plan, the maximum you can contribute is $5,000 per year.

References

• Bureau of Labor Statistics; Pretax Benefits: Access to Section 125 Cafeteria Benefits and Health Savings Accounts in the United States, Private Industry; Eli Stoltzfus
• IRS.gov: Publication 969 -- Health Savings Accounts and Other Tax- Favored Health Plans
• IRS.gov: FAQs for Government Entities Regarding Cafeteria Plans