What Is POP EE Pretax and How Does It Affect Your Paycheck?
Gain clarity on POP EE Pretax. Explore how this benefit mechanism impacts your earnings and tax position, optimizing your financial approach.
A Premium Only Plan (POP), often referenced as “POP EE Pretax,” allows employees to pay for qualified benefits like health, dental, and vision insurance premiums with pre-tax dollars. This reduces their taxable income and overall tax obligations. The plan operates under Internal Revenue Code Section 125.
Understanding Pre-Tax Premium Deductions
Pre-tax deductions for benefit premiums operate by subtracting the premium amount from an employee’s gross pay before federal income tax, most state income taxes, and Federal Insurance Contributions Act (FICA) taxes (Social Security and Medicare) are calculated. For example, if an employee earns $1,000 in gross pay and has a $100 pre-tax health insurance premium, their taxable income becomes $900. Taxes are then calculated on this reduced $900 amount, rather than the original $1,000 gross pay. This differs significantly from post-tax deductions, where the full gross pay is subject to all taxes first, and then the premium is deducted from the net amount. The pre-tax method effectively lowers the base upon which various taxes are computed, leading to tax savings for the employee.
Impact on Employee Taxes and Net Pay
Reducing taxable income through pre-tax deductions directly leads to a lower overall tax liability for the employee. This impacts federal income tax, state income tax (in most states), and FICA taxes. For instance, the employee’s portion of FICA tax is 7.65% (6.2% for Social Security on earnings up to $168,600 and 1.45% for Medicare with no wage limit), plus an additional 0.9% Medicare tax on wages exceeding certain thresholds. By lowering the taxable wage base, the amount withheld for these taxes decreases.
Consider an employee with a bi-weekly gross pay of $2,000 and a $200 pre-tax health insurance premium. Instead of paying taxes on $2,000, they pay taxes on $1,800. This $200 reduction in taxable income results in savings on federal income tax based on their marginal tax bracket, such as 10% or 12% for many individuals. They also save 7.65% on FICA taxes, amounting to $15.30 in this example.
Even though the employee’s gross pay is reduced by the premium amount, their take-home pay, or net pay, might not decrease by the full premium amount due to these tax savings. The actual savings depend on the employee’s specific tax bracket and the total amount of the pre-tax premium. Employees in higher tax brackets generally experience greater tax savings from pre-tax deductions.
Employer Requirements for Offering a POP
Employers must establish a formal written plan document, often referred to as a Section 125 plan or cafeteria plan, to offer a Premium Only Plan. This document outlines the plan’s specific provisions, eligibility rules, and the types of benefits offered. Employers must ensure the plan adheres to the regulations set forth in Internal Revenue Code Section 125.
Proper administration of a POP involves clear communication to employees about their benefit options and requiring formal employee elections to participate. Employers must also conduct non-discrimination testing annually to ensure the plan does not favor highly compensated employees or key employees regarding eligibility or benefits.