Do you know which is better? Should we be paying health insurance premiums pre-tax or post-tax? This is a question I had to answer myself for open enrollment this year. It’s also an option that I have never seen since I’ve been enrolling in health insurance. My wife’s employer has the option of either enrolling in a post-tax plan or a pre-tax plan. The two plans are identical, except for which side of taxes the premium comes out. Most employers, like mine, only give the option of premiums being taken out pre-tax.
So, I set about researching why one would choose to have premiums taken out post-tax. I couldn’t find the information concisely written or in a format that I preferred. I had to hop around to several different websites to collect the necessary information.
Here are the results of my research.
Disclaimer: I am not a tax expert. This is just my opinion based upon my research.
Note: My argument is making the assumption that you are employed and/or have the choice of paying your insurance pre-tax.
Conclusion
Spoiler Alert! – Skip the next sentence if you prefer to remain in suspense until the end! I know this is an exciting topic.
Pay your premiums using pre-tax dollars when given the option.
Related: 2019 & 2020 Federal Income Tax Brackets
Tax Deductions
Which will save me the most money? This is the main question to be answered, and the savings come in the form of how many tax dollars you don’t have to pay.
Pre-tax
- Deductions on premiums are guaranteed – You don’t have to itemize on your tax return
- If you choose to itemize your taxes, you still can deduct medical expenses, just not what was pre-tax (the premium) and portions paid with HSA dollars. (AKA: No double dipping)
Post-Tax
- Must itemize on your taxes
- Therefore, your itemized deductions must be > Standard deduction
- Standard Deduction for 2020 = $12,400 single or $24,800 married filing jointly
- Therefore, your itemized deductions must be > Standard deduction
- Assuming you have a High Deductible Health Plan (Most common type of insurance these days), tax law only allows Out-of-Pocket maximums of $6,900 for individuals, or $13,800 for families.
- That means you would have to come up with $5,500 single or $11,000 married filing jointly, on top of what you didn’t spend in medical expenses to beat the standard deduction.
One very important tax law that affects your itemized deductions, independent of if you paid your health premiums pre-tax or post-tax:
- Only medical expenses > 10% of AGI count towards deduction.
Examples
All that can be a bit much to take in, so let’s take a look at a few examples. In the examples, we have a married couple with one child, who will be using a High Deductible Health Plan. The monthly premium is $200/mo. or $2400 for the year. They are a middle-class family that made $100,000 in Adjusted Gross Income (AGI) in 2019, putting them squarely in the 22% tax bracket. They choose not to contribute to an HSA. (Not contributing to an HSA is a bad idea, but makes the example easier to follow.)
Note: If you are filing your taxes and paying health insurance as a single person, you can basically cut these numbers in half to see how they would affect you.
Example 1:
The family has a good year medically speaking. They didn’t have any medical expenses, since routine check-ups are covered free of charge by the insurance. That means they only had to pay their insurance premiums over the course of the year, a total of $2400.
Pre-Tax:
If the family choose to pay their premium pre-tax, they would have saved $528 in taxes. ($2,400 premiums x .22 tax rate) = $528. There were no medical expenses, so nothing could be itemized for medical expenses when doing their tax returns.
Post-Tax
If the family choose to pay their premium post-tax, they would have saved $0 in taxes. There medical expenses were $2,400 from paying the premiums, but this is way less than $10,000, 10% of their AGI. As a result, nothing could be itemized for medical expenses when doing their tax returns.
Example 2:
The family has a bad year medically speaking. They had lots of medical expenses, and ended up reaching their out-of-pocket max of $13,800. They also had to pay their insurance premiums over the course of the year, $2400, so they ended up paying $16,200 in medical expenses.
Pre-Tax:
If the family choose to pay their premium pre-tax, they would have saved at least $528 in taxes. ($2,400 premiums x .22 tax rate) = $528. If they choose to itemize, they paid $13,800 in after tax dollars. That means they could deduct an additional $3,800 ($13,800 (medical expenses) – $10,000 (10% of AGI)). They would need to find another $20,200 in itemized deductions to match the $24,000 standard deduction.
Post-Tax
If the family choose to pay their premium post-tax, they potentially have saved $0 in taxes (if they do not or cannot itemize). If they do itemize, they paid $16,200 in after tax dollars. That means they could deduct an additional $6,200 ($16,200 (medical expenses) – $10,000 (10% of AGI)). They would need to find another $17,800 in itemized deductions to match the $24,000 standard deduction.
Example 2 shows the most a family can deduct in medical expenses in a given year, plus or minus the cost of health insurance. The out-of-pocket max is set by federal law. Assuming you go to in-network providers, your medical costs will never exceed this.
Example 3:
Just for fun, I went to the open exchange, healthcare.gov, to price out plans for our example family, in case they didn’t want health insurance through their employers. I put ages 40 and 38 for the parents and age 11 for the child. I also put that they live in Texas.
There was only one High Deductible Health Plan option available. I’ll round the monthly premium to $1000/mo or $12,000 for the year.
As in example 2, the family has a bad year medically speaking. They had lots of medical expenses, and ended up reaching their out-of-pocket max of $13,800. They also had to pay their insurance premiums over the course of the year, $12,000, so ended up paying $25,800 in medical expenses.
Pre-Tax: (Not an option for the open exchange, but for comparison)
If the family choose to pay their premium pre-tax, they would have saved at least $2,640 in taxes. ($12,000 premiums x .22 tax rate) = $2,640. If they choose to itemize, they paid $13,800 in after tax dollars. That means they could deduct an additional $3,800 ($13,800 (medical expenses) – $10,000 (10% of AGI)). They would need to find another $20,000 in itemized deductions just to match the $24,000 standard deduction.
Post-Tax
If the family choose to pay their premium post-tax, they potentially have saved $0 in taxes (if they do not or cannot itemize). If they do itemize, they paid $25,800 in after tax dollars. That means they could deduct an additional $15,800 ($25,800 (medical expenses) – $10,000 (10% of AGI)). They would need to find another $8,000 in itemized deductions just to match the $24,000 standard deduction.
Example 3 was shown to demonstrate what it would cost if you had to pay for insurance on your own and had a bad year, but still had a good income. If you’re AGI is low enough (around $50,000 to $60,000), you begin receiving tax credits, and the premiums start going down. The lower your AGI, the more credits you receive, until the plans are nearly free.
The Itemized Deduction Over the Standard Deduction
Now you might be asking yourself, “When does it make sense to do the itemized deduction instead of taking the standard deduction?” The answer is actually simple. For our example family, they are married filing jointly, so their standard deduction is $24,000. If your itemized deductions are greater than $24,000, than you should take the itemized approach. The tricky part is figuring out if you have enough deductions to reach that much.
What Qualifies?
Common expenses that qualify for itemized deductions include:
- Medical expenses (Of Course!)
- Home mortgage interest
- Property, state, and local income taxes
- Charitable contributions (Includes tithes & giving to a church)
The important part to look at in this pre-tax, post-tax argument is the difference in qualifying medical expenses. For our example family, the most they can deduct in medical expenses is $3,800 pre-tax, or $6,200 post-tax. The difference between post-tax and pre-tax is the annual cost of your health premiums, $2,400 for our example family, or at most $12,000.
You might be thinking post-tax health insurance premiums may be more beneficial if they help to push your itemized deductions over that $24,000 mark. However, that is not the case. First, let’s take a look at this chart showing tax savings if you did file an itemized return.
Hold on a second…
Now, you may be thinking that I just contradicted myself. That chart clearly shows a window where post-tax is better than pre-tax. That is true, however, don’t forget that you can always file a standard return. In which case, your tax savings would always be $5,808 (Pre-tax tax savings + Standard deduction tax savings). Notice in the chart that $5,808 is where pre-tax starts matching post-tax.
From this we learned that even if the post-tax premiums do push you over the standard deduction amount, there is still potential not to recoup as much tax savings as you could have with pre-tax premiums. Secondly, we learned that there is never a situation where post-tax premiums save you more than pre-tax premiums. Perhaps this is why most employers only offer pre-tax plans and don’t give the employee a choice.
If you pay your health insurance premiums using pre-tax dollars, you will always reap the tax-savings. If you pay your health insurance premiums using post-tax dollars, you have to itemize your deductions to reap tax-saving, and to be able to itemize your deductions have to be greater than $24,000 + The Cost of Health Premiums. Also, doing itemized deductions takes a lot more time and requires keeping records for each deduction in case of a tax audit. Save yourself the time, the risk, and the hassle; pay your health insurance premiums with pre-tax dollars. As an added perk, you’ll get a slightly bigger paycheck.
FIRE Away!