Opting Out of Health Insurance: Employee Compensation in Lieu of Benefits

Should you be paying employees who opt out of health insurance? Many employers are finding such “cash-in-lieu” or “opt-out” programs can reduce insurance costs.

This setup may sound especially attractive to business operating on tight budgets — and to those with 50 or more employees, who must offer affordable health insurance coverage or be subject to tax penalties based on the Affordable Care Act’s employer mandate. But there are several caveats that employers need to be aware of.

Here’s what you need to know about paying employees who opt out of health insurance.

Opt-Out Regulations

While opt-out arrangements may be legal, there are a few facts that businesses should bear in mind. According to Group Health Solutions, cash in lieu of health insurance:

  • Is taxable
  • Should not be provided to enable an employee to purchase an individual policy
  • Must be offered to all eligible employees, not just a select few

Employers can choose one of the following opt-out arrangements:

  1. Unconditional opt-out: This option does not require proof of coverage from other sources, but the opt-out payment must be assessed as part of the employer’s ACA affordability calculation. As of 2018, according to SHRM, the cost of coverage is considered “affordable” if it doesn’t exceed 9.69 percent of the employee’s annual household income. However, the fact that employees can simply keep the cash without evidence of health care coverage elsewhere could be an issue if questions arise in the future.
  2. Conditional opt-out: This is an arrangement that requires proof of employee health coverage through another source, such as a spouse’s employer. Employees can fill out an attestation form that can be filed to avoid the affordability penalty. This option requires more administrative legwork than its unconditional counterpart.

Pros and Cons of Opt-Out Payments

The first advantage of opt-out arrangements is extra cash in some employees’ pockets. At the same time, opt-out payments may reduce your overall health insurance costs as an employer, if the cash you provide in lieu of coverage is less than you would spend on health coverage.

Open Enrollment: When Employees Opt Out from The Benefits Guide on Vimeo.

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However, there are drawbacks. First, there’s an administrative burden to consider. Opt-out arrangements create extra work in the form of documentation, payouts and managing annual enrollment. For employees, the fact that opt-out cash — unlike money set aside for health premiums — qualifies as taxable income means that they may owe more money and have to make sure they account for it appropriately.

Ensuring Compliance

To avoid violating IRS regulations, it’s best to both review plan documents to update opt-out conditions and prepare effective employee communication resources that explain the opt-out provisions and the timeline for submitting proof.

Before offering a health plan cash-out option, you should consult with your health insurance company and a tax advisor to confirm that such an arrangement complies with the law and is beneficial for your business.

Don’t forget to make sure that an opt-out program would meet your workplace employment and financial goals. From there, you can share the news with your employees that they have a new option when it comes to their health benefits.

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This content is provided solely for informational purposes. It is not intended as and does not constitute legal advice. The information contained herein should not be relied upon or used as a substitute for consultation with legal, accounting, tax and/or other professional advisers.

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