Compensation in Lieu of Health Insurance: What to Know

Compensation in lieu of health insurance is a financial arrangement where an employer offers a taxable cash payment to an employee who voluntarily declines enrollment in the company-sponsored group health plan. Businesses may utilize these programs, often called health insurance waivers or cash-out options, to manage their employee benefits expenditures or to offer greater flexibility to their workforce. The structure of these arrangements is subject to specific federal regulations.

Affordable Care Act (ACA) Compliance

A health insurance waiver program’s viability depends on rules from the Affordable Care Act (ACA), particularly for certain employers. Businesses classified as Applicable Large Employers (ALEs), generally those with 50 or more full-time equivalent employees, are subject to the Employer Shared Responsibility Provisions (ESRP). These provisions require ALEs to offer affordable, minimum-value health coverage to their full-time employees or face potential penalties. A waiver payment can complicate this requirement by affecting the affordability calculation.

The issue is how the cash payment influences the perceived cost of the health plan for an employee. The employee’s required contribution is a factor in affordability. Under IRS regulations, if an employer offers an “unconditional” waiver payment, meaning the employee receives the cash simply for declining coverage without having to prove they have other insurance, the value of that payment must be added to the employee’s premium contribution. This increases the calculated cost of coverage, making it more likely to be deemed unaffordable.

For example, if an employee’s premium share is $200 per month and they are offered a $150 monthly unconditional cash waiver, the ACA affordability test considers their contribution to be $350. This amount can exceed the affordability threshold, which for 2025 is 9.02% of the employee’s household income. An unaffordable offer can expose an ALE to penalties if the employee then receives a premium tax credit for a marketplace plan.

To navigate this, employers can implement a “conditional” waiver program, structured as an “eligible opt-out arrangement.” In this design, the employee only receives the cash payment if they decline the employer’s plan and attest that they have alternative minimum essential coverage from another source, such as a spouse’s plan. When structured this way, the waiver payment is not added to the employee’s contribution for the affordability test, allowing the employer to offer the cash incentive without risking non-compliance.

Taxation of Health Insurance Waiver Payments

A cash waiver payment is treated as taxable income for the employee. Unlike employer contributions toward health insurance premiums, which are excluded from an employee’s gross income, cash-out payments are considered wages. This means the funds are subject to federal and state income tax withholding, as well as Social Security and Medicare taxes under the Federal Insurance Contributions Act (FICA).

This tax treatment reduces the net financial benefit of the waiver for the employee. For instance, a $2,000 annual waiver payment will be diminished by these various taxes, resulting in a lower take-home amount.

For employers, these waiver payments are handled like other cash compensation, such as salary or bonuses. The payments are a deductible business expense, which can lower the company’s overall taxable income. The employer is also responsible for paying its share of payroll taxes on the waiver amount. This includes the employer’s portion of FICA taxes and federal unemployment taxes (FUTA).

Implementing a Formal Program

The foundation of the program should be a formal, written plan document. This document, typically an amendment to the company’s Section 125 cafeteria plan, must explicitly outline the terms of the cash-out option, ensuring it is offered uniformly to all eligible employees. It should detail who is eligible, the amount of the payment, and the conditions for receiving it.

The employee waiver or declination form is a required component of implementation. This document serves as the official record of the employee’s choice and is used for demonstrating compliance. The form must clearly present the offer of group health coverage, state the employee’s share of the premium cost for the lowest-cost option, and specify the exact dollar amount of the cash payment being offered.

The waiver form needs a section where the employee formally acknowledges they were offered coverage and are voluntarily declining it. If the employer is an ALE using a conditional program to meet ACA affordability rules, the form must include an attestation. In this section, the employee must certify that they have or will have other minimum essential coverage for the period the waiver applies. This attestation helps document that the program qualifies as an eligible opt-out arrangement.

The process must be managed consistently each plan year, with employees required to make a new election annually during the open enrollment period. The waiver amount should be a fixed, flat-dollar amount for all eligible employees to avoid potential discrimination issues.