Whether pre-tax or after-tax health insurance is better for you depends on your individual circumstances, including your income tax bracket, expected medical expenses, and other financial goals.
Understanding Pre-Tax and After-Tax Health Insurance
Before we compare pre-tax and after-tax health insurance, let’s first understand what they mean and how they work.
What is Pre-Tax Health Insurance?
Pre-tax health insurance is a health insurance plan that allows you to pay your premiums with money that is deducted from your gross income before any taxes are withheld. Simply put, the amount of your premiums is subtracted from your taxable income and tax bill. You must be enrolled in an employer-sponsored health insurance plan to pay your premiums with pre-tax money. Examples of employer-sponsored plans with qualifying pre-tax premiums include:
- Major medical coverage
- Supplemental/voluntary coverage
- Contributions to health spending accounts, like health reimbursement accounts (HRAs), health savings accounts (HSAs), and flexible spending accounts (FSAs).
- Employer-sponsored reimbursements for medical premiums
Check your pay stub for an area called “Deductions” or something similar to see if your health insurance payments are paid for before taxes. This section shows your health insurance premium. If it is taken out of your gross pay, it is a pre-tax payment.
What is After-Tax Health Insurance?
After-tax health insurance is a health insurance plan that requires you to pay your premiums with money that is deducted from your net income after taxes are withheld. This means that your taxable income and tax liability are not affected by the amount of your premiums. If your company does not provide a pre-tax plan, you may pay your premiums after-tax. Examples of after-tax health insurance include:
- Individual health insurance plans that you purchase on your own
- Supplemental insurance plans that you purchase from your employer with after-tax dollars
- Medical expenses that you pay out of pocket, such as co-payments, prescription costs, and co-insurance amounts
You can confirm if your health premiums are after-tax by viewing your pay stub and looking for a column titled “Net Pay” or something similar. If your health premium is not deducted from your gross pay, it is an after-tax premium.
Comparison of Pre-Tax and After-Tax Health Insurance
Now that we know what pre-tax and after-tax health insurance are, let’s compare their tax implications and see how they affect your finances.
Tax Benefits of Pre-Tax Health Insurance
The main benefit of paying your health insurance premiums with pre-tax money is that you get a tax break on your income. By reducing your taxable income, you also reduce the amount of taxes that you owe to the federal, state, and local governments. Depending on your tax bracket and the amount of your premiums, you could save up to 40% on income taxes and payroll taxes by paying your premiums with pre-tax money.
Tax Deductions for Pre-Tax Premiums
Another benefit of paying your health insurance premiums with pre-tax money is that you do not need to itemize your deductions to claim them on your tax return. Since your premiums are already excluded from your income, you do not need to report them as an expense. This simplifies your tax filing process and saves you time and money.
Tax Implications of After-Tax Health Insurance
The main drawback of paying your health insurance premiums with after-tax money is that you do not get a tax break on your income. Your taxable income and tax liability are the same regardless of the amount of your premiums. This means that you are paying more taxes than you would if you paid your premiums with pre-tax money.
Tax Deductions for After-Tax Premiums
However, there is a way to get some tax relief on your after-tax health insurance premiums. The IRS allows taxpayers who itemize their deductions to claim certain medical expenses as a deduction on their tax return. Deductible medical expenses include those paid with after-tax dollars only, such as:
- Individual or supplementary health insurance premiums
- Costs like co-payments, prescriptions, and co-insurance
- Medical bills beyond your deductible
There are, however, conditions and restrictions that must be met before this deduction may be used. Firstly, in 2023, you will only be able to deduct medical costs that are more than 7.5% of your AGI. Secondly, you need to keep track of and save your receipts for all of your medical costs. Thirdly, you must submit a Schedule A with your Form 1040 to itemize your deductions.
Advantages and Disadvantages of Pre-Tax and After-Tax Health Insurance
Both pre-tax and post-tax health insurance have benefits and drawbacks to consider. The pros and cons of each choice are outlined below.
Pros of Pre-Tax Health Insurance
- Lower taxable income and tax liability
- Higher net pay and disposable income
- No need to itemize deductions or keep records of medical expenses
- More options and flexibility for employer-sponsored plans
Cons of Pre-Tax Health Insurance
- Less control and choice over individual plans
- Less opportunity to claim medical expense deductions
- Possible Effects on Medicare and Social Security
- Potential penalty for early HSA/FSA withdrawal
Pros of After-Tax Health Insurance
- More control and choice over individual plans
- More opportunities to claim medical expense deductions
- No impact on Social Security and Medicare benefits
- No penalties for early withdrawal from HSAs or FSAs
Cons of After-Tax Health Insurance
- Higher taxable income and tax liability
- Lower net pay and disposable income
- Need to itemize deductions and keep records of medical expenses
- Fewer options and flexibility for employer-sponsored plans