Premium-only plans (POPs) have become increasingly popular in employee benefits, in large part because these plans allow employees to pay their share of insurance premiums with pre-tax dollars, leading to considerable tax savings for both employers and employees. While many understand the tax advantages of POPs, it’s important to note that certain requirements must be met to maintain compliance.
What is a Section 125 POP and how does it work?
A premium-only plan (POP) is the most basic and popular type of Section 125 plan. It is an IRS-regulated, employer-sponsored benefit plan that allows employees to purchase insurance using pre-tax income. Ultimately, it enables employers and employees to reduce their income tax liabilities since the purchase is made before the deductions of Federal, State and FICA payroll taxes.
Benefits typically offered within a POP include health, dental, vision, accidental death and dismemberment, hospital indemnity, short- and long-term disability, and group life insurance up to $50,000. Health savings account (HSA) and flexible spending account (FSA) contributions can also be made pre-taxed. Hence, combining a POP with these savings plans is cost-effective and beneficial to employers and employees.
Tax Savings Benefits of a Premium-Only Plan (POP)
Employer Savings Benefits
Employers may see around a 10% tax savings due to lower FICA/FUTA (Social Security, Medicare, Federal and state unemployment taxes) and workers’ compensation taxes, depending on the state. In addition, many employers have experienced higher employee morale due to increased take-home pay.
Employee Savings Benefits
Under Section 125 POP, employees' take-home pay is increased, which helps reduce the high cost of providing coverage for family members. Employees can often realize 20%-40% in tax savings because health insurance premiums paid by the employee are exempt from payroll taxes. Depending on state regulations, savings are experienced on city, state and federal income taxes, including Medicare and Social Security.
Compliance Requirements for Section 125 Plans
A cafeteria plan requires several necessary documents. These documents include a main plan document and an adoption agreement, which may be combined into one document. These documents outline the legal and employer-specific aspects of the benefits plan, including the benefits offered, eligibility criteria, contribution methods, and other legal notices.
Employee benefit plans are usually subject to the Employee Retirement Income Security Act (ERISA) and must provide a summary plan description (SPD). The SPD is a simplified explanation of the primary plan document and adoption agreement that outlines the details of the cafeteria plan. All eligible employees must receive a copy of the SPD. The plan documents must be revised and amended every five years to include any relevant plan changes or regulatory updates.
Employers offering a POP must perform nondiscrimination testing annually to ensure the benefit plan does not discriminate in favor of certain highly compensated or key employees. Highly compensated employees must receive a lower percentage of benefits compared to non-highly compensated employees. Passing nondiscrimination testing will ensure that organizations can continue to provide highly compensated employees with pre-tax benefits. All tests should be kept on file in case of an audit.
Offering a premium-only plan is an excellent way to help employees reduce taxes and increase take-home pay while receiving quality benefits. This can also help your organization save on tax liabilities. However, setting up the plan can be complicated and time-consuming due to the administrative tasks involved, ensuring you comply with the Internal Revenue Service and Department of Labor, and completing nondiscrimination testing.
Partnering with a Section 125 professional can significantly reduce the burden and time consumption associated with a POP. If you’re interested in setting up a premium-only plan or need help with Section 125 Plan Documents, CBIZ can help. Connect with us today.