How to Set Up Cash-in-Lieu of Group Health Insurance Benefit Option

A Section 125 Premium Only Plan (POP) is required to offer the Cash-in-Lieu benefit arrangement  correctly.  The Cash-in-Lieu option is offered by some employers to provide flexibility to their employees when it comes to their health benefits. To break it down:

Section 125 Premium Only Plan (POP):

A Section 125 plan is a tax-advantaged arrangement defined by the Internal Revenue Code Section 125 that allows employees to pay for certain benefits—most commonly, health insurance premiums—using pre-tax dollars. This means employees can reduce their taxable income by the amount they contribute to the plan.

A Premium Only Plan (POP) is the simplest and most common type of Section 125 plan, where an employer allows employees to pay for their health insurance premiums (either group health insurance or individual policies) on a pre-tax basis.

How Does the POP Work?

1. Employee Contributions:
   • Employees elect to have a portion of their salary deducted (pre-tax) to cover their health insurance premiums.
   • The deductions come out of their paycheck before taxes are calculated, which lowers their taxable income and therefore their federal, state, and FICA (Social Security/Medicare) taxes.
2. Employer Role:
   • Employers handle the administration of the plan and ensure that the premiums are paid to the insurer, but they do not contribute directly to the premium.
   • This type of plan is very straightforward and does not require complex benefits management.

Cash-in-Lieu Option (also called “Cash-in-Lieu of Health Benefits”):

The Cash-in-Lieu option is a benefit offering that allows employees to choose between receiving health insurance coverage or opting for a cash payment instead. The employee effectively declines the health insurance offered by their employer and instead receives a set amount of money, usually added to their paycheck.

When a Cash-in-Lieu option is tied to a Section 125 POP, here’s how it typically works:

1. Employee Choice:
   • Employees have the option to either:
     • Enroll in employer-provided health insurance and have their premiums paid via the Section 125 POP (pre-tax) OR
     • Opt out of the health insurance plan altogether and instead receive a cash benefit.
2. Cash Payment:
   • If the employee chooses the cash-in-lieu option, the employer provides a cash payment (usually in the form of additional salary or a direct bonus).
   • The cash payment can be used by the employee as they wish—perhaps to purchase alternative health insurance or for other expenses.
3. Tax Implications:
   • If the employee chooses the cash payment option, the cash benefit is typically taxable income, meaning it is subject to federal income taxes and other payroll taxes (like FICA).
   • On the other hand, if the employee opts to participate in the health insurance plan and pays premiums through the Section 125 POP, the premiums are deducted from their paycheck pre-tax, reducing their taxable income.
4. Eligibility for Other Plans:
   • The cash-in-lieu option is often used by employers who offer a group health insurance plan but want to give employees the flexibility to opt-out (often in situations where an employee already has coverage through a spouse or another source).
   • In some cases, the employee can use the cash payment to buy their own health insurance, either on the individual market or through a government exchange, but the amount received typically won’t be enough to fully cover the cost of individual insurance premiums.

Example Scenario of the POP with Cash-in-Lieu Option:

Employee: Sarah works at a company that offers a group health insurance plan through a Section 125 Premium Only Plan.

Option 1 (Enroll in Health Insurance): Sarah can enroll in the employer’s health insurance plan, and her premiums will be deducted from her paycheck pre-tax under the Section 125 POP. This reduces her taxable income and saves her money on taxes.

Option 2 (Cash-in-Lieu): Sarah does not need health insurance through her employer (perhaps she’s covered by a spouse’s plan), so she chooses to decline the employer-sponsored plan. Instead, she receives a $300 per month cash payment from her employer, which is added to her salary. However, the $300 is considered taxable income, so it’s subject to federal income tax and payroll taxes.

Why Employers Offer a Cash-in-Lieu Option?

Cost Savings: Employers can save money by offering the cash-in-lieu option rather than having to pay the cost of health insurance premiums for employees who don’t need coverage.

Flexibility for Employees: It gives employees who are already covered by another plan (such as a spouse’s insurance) the option to receive extra cash instead of paying for redundant coverage.

Attracting Talent: Employers may use the cash-in-lieu option as a tool to make their benefits package more attractive or flexible for a broader pool of employees.

Potential Drawbacks for Employees:

Taxable Income: The cash received is taxable, meaning the employee won’t save money on taxes the way they would by contributing to the Section 125 Premium Only Plan.

Not a Full Replacement for Insurance: The amount of money received may not be enough to purchase health insurance on the open market, so employees might need to rely on other sources of coverage.

Considerations for Employers:

Compliance: Employers must make sure they comply with applicable regulations when offering a cash-in-lieu option, especially in relation to how the cash payment is treated for tax purposes.

Equity: It’s important that the cash-in-lieu option is offered equitably to all employees, and not in a way that could be seen as discriminatory.

Alternative Health Coverage: Employers may also need to ensure that employees who choose the cash-in-lieu option have access to alternative health coverage, such as through a spouse’s plan or individual policies.

Applicable Large Employers or ALEs: If the employer providing the cash-in-lieu of benefits option is classified as an Applicable Large Employer (ALE) under the Affordable Care Act (ACA)—meaning the employer had an average of 50 or more full-time and full-time-equivalent (FT+FTE) employees over the previous twelve months—specific requirements must be met. The amount given as “cash in lieu of benefits” must factor into the affordability assessment, unless this choice is categorized as an “eligible opt out arrangement.” For the option to be regarded as an “eligible opt out arrangement,” the employee must decline employer-sponsored coverage and must confirm annually that they possess Minimum Essential Coverage (MEC) from a source other than an Individual & Family Plan.

In Summary:

A Section 125 Premium Only Plan (POP) with Cash-in-Lieu is a benefit structure where employees are given the option to either:

Participate in the employer’s group health insurance plan and pay premiums with pre-tax dollars (reducing their taxable income),

Or opt out of the employer’s health plan and instead receive a cash payment (which is taxable).

This option provides flexibility for employees who don’t need the employer’s health insurance plan (because they have coverage elsewhere) and allows them to receive some compensation for opting out. However, the cash payment is taxable and may not be enough to cover individual health insurance costs.

Let me know if you need more details or examples!

Additional resources:

Cash-in-lieu option must follow Section 125 IRS rules