There are tax savings associated with the Federal Employees Health Benefits (FEHB) program, the Federal Employees Dental and Vision Insurance Program (FEDVIP), and the health care flexible spending accounts (HCFSAs) offered through FSAFEDS.
These tax savings are discussed in this column.
SEE ALSO:
1. Employer (federal government) share of FEHB program premiums
The employer share of FEHB health insurance premiums paid by federal agencies for federal employees and by OPM for annuitants is part of employee compensation and retirement income, respectively. However, IRS rules exempt employer-paid health insurance premiums from taxable income. The amount paid by federal agencies (approximately 72 to 75 percent of the FEHB program premium) does not appear on an employee’s annual W-2 statement. Similarly, the amount paid by OPM on behalf of federal annuitants for their FEHB program premiums does not appear on a federal annuitant’s annual CSA 1099-R statement. The same applies to survivor annuitants, in which the amount of the FEHB program premiums paid by OPM on behalf of a survivor annuitant does not appear on the survivor annuitant’s annual CSF 1099-R statement.
2. Employee share of FEHB program premiums
The employee-paid portion of the total FEHB premiums (on average, 25 to 28 percent of the premiums) and 100 percent of the FEDVIP premiums paid by employees enrolled in the FEDVIP pay via payroll deductions are sheltered from federal and state income taxes and payroll taxes (Social Security or FICA and Medicare Part A Hospital Insurance Tax). Deducting premiums from an employee’s gross salary is called premium conversion. Employees have the option to not participate in premium conversion when it comes to the FEHB program but not when it comes to the FEDVIP. Federal annuitants and survivor annuitants are not permitted by IRS rules to participate in premium conversion. Additional information on premium conversion is presented below.
3. Participation in Health Care Flexible Spending Accounts
All permanent employees (including full-time and part-time employees, whether or not they enrolled in the FEHB program and/or the FEDVIP) are permitted to set aside a portion of their gross salary (before all taxes – federal and state income taxes and Social Security/FICA and Medicare Part A/Hospital Insurance payroll taxes) into a health care flexible spending account (HCFSA). During 2024, employees may set aside a maximum of $3,200 of their gross salary into their HCFSA. The $3,200 will most likely increase to as much as $3,300 or $3,400 for 2025. All qualified withdrawals from the HCFSA to pay out-of-pocket medical, dental and vision expenses are tax-free. A more detailed discussion of HCFSAs and their benefits will be presented in an upcoming column.
Participation in Premium Conversion
Federal employees (but not federal retirees) automatically use before-taxed dollars (deducted from their gross salary) in order to pay their portion of FEHB program insurance premiums. These before-taxed dollars include all taxes (federal and state income taxes, and Social Security/FICA and Medicare Part A/Hospital Insurance Tax payroll taxes. This is called premium conversion. The result is a reduction of employee’s annual taxable salary, leading to a reduction in the employee’s annual federal and state tax liabilities. The amount of annual federal and state income tax savings depends on: (1) Total employee- paid FEHB program premiums; and (2) The employee’s federal and state marginal income tax brackets.
Those employees who are enrolled in the Federal Employees Dental and Vision Insurance Program (FEDVIP) also participate in premium conversion. Note that employees who participate in the FEDVIP contribute the entire amount of FEDVIP premiums with no federal government contribution towards FEDVIP premiums.
There is one difference between employee participation in premium conversion when it comes to the FEHB program and the FEDVIP. With respect to the FEHB program, an employee can choose not to participate in premium conversion. But the employee is required to participate in premium conversion when it comes to participation in the FEDVIP program.
There are three reasons why a federal employee may not want to participate in premium conversion when it comes to the FEHB program: The reasons are: (1) “Flexibility”; (2) Decrease in future Social Security retirement benefits; and (3) Possible itemization of medical and dental expenses on the employee’s federal income tax returns. These reasons are discussed in more detail:
• “Flexibility.” Those employees who waive premium conversion participation must make that request during the annual FEHB program open season. Employees who waive premium conversion participation during the open season can drop their FEHB program participation during the subsequent plan year without providing a valid reason as to why they are no longer participating in the FEHB program. In addition, In addition, if an employee waives premium conversion participation during the open season, the employee during the subsequent plan year can change their enrollment type from self and family to self plus one, or to self only at any time during the year, even in the absence of a qualifying life event.
• Effect on future Social Security monthly retirement benefits. Employee participation in premium conversion could result in future diminished Social Security monthly retirement benefits. But the monthly reduction in Social Security retirement benefits is negligible compared to current year federal and state income tax savings.
• Itemizing deduction on federal income tax returns. Employees who participate in premium conversion are not permitted by IRS rules to include the premiums they pay for their FEHB program health plan premiums and FEDVIP dental and/or vision insurance premiums as qualified medical and dental expenses as part of their itemized deductions on their federal income tax return. Qualified out-of-pocket medical and dental expenses are an itemized deduction, assuming an individual itemizes on his or her federal income tax return, rather than taking the “standard deduction.”
However, in order for an employee to include out-of-pocket medical and dental expenses as an itemized deduction, the total amount of out-of-pocket medical and dental expenses has to exceed 7.5 percent of the employee’s adjusted gross income. Most employees enrolled in the FEHB program will most likely not be able to exceed the 7.5 percent of adjusted gross income threshold. Included in the out-of-pocket medical and dental expenses are deductibles, copayments and coinsurance. Not included are FEHB program health care premiums if the employee participates in premium conversion. However, if an employee anticipates a year in which there will be above average out-of-pocket medical expenses including health insurance premiums, then waiving participation in “premium conversion” for that year may make sense from the standpoint of overall tax savings.
Note that employees who waive premium conversion participation for one year can reenroll in premium conversion in a future year. Enrollment and disenrollment in premium conversion is made during the annual federal benefits open season.