Using Payroll Deduction to Shelter Individual Health Insurance from Income Tax

This article examines the use of "Section 125" cafeteria plans offered by employers to shelter individual health insurance premiums from income tax. Little is known about the availability and use of these plans, particularly for employees who are not offered employer-based health insurance.

The authors conducted 65 semi-structured, open-ended interviews with insurers, insurance agents, government officials, and administration firms in Indiana, Massachusetts and Missouri. The results were coded and analyzed.

Key Findings:

  • Employers rarely offered Section 125 plans to purchase individual health insurance despite significant potential savings to both employers and employees. In most states, there is no legal mandate to offer Section 125 plans for individual insurance through the workplace.
  • Many respondents expressed concern about whether Section 125 plans violated state or federal law. Some respondents also felt that increased use of Section 125 plans for individual insurance might undermine employer-based health insurance benefits.
  • There was significant variation between states in Section 125 policies and market context.

While Section 125 cafeteria plans have potential to help individuals by sheltering individual health insurance premiums from income tax, currently these plans are rarely offered to employees.

This article appears in a special issue of the journal HSR: Health Services Research. The study was carried out through the Robert Wood Johnson Foundation’s State Health Access Reform Evaluation (SHARE). SHARE guides the implementation of health reform and supports research on the expansion of health insurance coverage.