Enrollment Types and Tax Savings Associated with the FEHB Program
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Tax Savings Associated with the FEHB Program, FEDVIP and Health Care FSAs for Federal Employees
Participation in Premium Conversion
Federal employees (but not retirees) use before-taxed dollars (deducted from their bi-weekly gross salary) to pay their portion of the FEHB program insurance premiums. These before-taxed dollars include all taxes – federal and state income taxes, and Social Security (FICA) and Medicare Part A payroll taxes. This is called “premium conversion”. The Internal Revenue Code allows employees to deduct their portion of the total premiums paid for FEHB program health insurance from their gross salary. The result is a reduction of the employee’s taxable salary, leading to a decrease in the employee’s annual federal income tax liability. The amount of federal and state income tax annual savings depends on: (1) Total employee paid FEHB premiums; and (2) The employee’s federal and state marginal income tax brackets.
Those employees who are enrolled in the Federal Employee Dental and Vision Insurance Program also participate in premium conversion. Employees pay the full amount of FEDVIP premiums (no federal government contribution) for dental and/or vision insurance.
There is one difference between employee participation in premium conversion when it comes to the FEHB program and to the FEDVIP. With respect to the FEHB program employes can choose not to participate in premium conversions whereas with the FEDVIP, employees are required to participate in premium conversion.
An employee may not want to participate in premium conversion when it comes to the FEHB program for three reasons, namely: (1) “Flexibility”; (2) Effect on future Social Security retirement benefits; and (3) Itemizing medical expenses on their federal income tax returns. These reasons are discussed further below.
- “Flexibility”. Those employees who waive premium conversion participation can drop their FEHB program health insurance participation in the middle of the year without giving any reason. Employees can change their enrollment type from self and family to self plus one, or to self only any time during the year, even in absence of a life event. Employees who participate in premium conversion can make these changes only if there is a qualified life event.
- Effect on future Social Security monthly retirement benefits. Employee participation in premium conversion will lead to diminished future Social Security monthly retirement benefits. But the reduction in benefits is small compared to current year tax savings in federal and state income taxes.
- Itemizing deductions on federal income tax returns. Employees who participate in premium conversion are not permitted to include the premiums they pay for the FEHB program and the FEDVIP premiums as qualified medical and dental expenses on their federal income tax returns. This assumes that an employee itemizes (files Schedule A) on their federal income tax return. Most individuals do not itemize. For an employee to include out-of-pocket medical expenses as deductible expenses, the total amount of medical expenses has to exceed 7.5 percent of the employee’s adjusted gross income (AGI). Most employees enrolled in the FEHB program will most likely not be able to surpass the 7.5 percent AGI threshold. However, there may be a year in which an employee anticipates above average out-of-pocket medical expenses and, when including the FEHB program premiums, they will meet or exceed the 7.5 percent AGI threshold. In that case, waiving premium conversion participation will be to the employee’s advantage. Note that employees who waive premium conversion for a particular year can reenroll in premium conversion in the following year. The election to participate or not participate in premium conversion is always made during the FEHB program open season.
Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street - Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.