If you have elected family health coverage through your employer and your premiums are $350 a month then it would be easy to think that the net effect on your paycheck would be $350 a month.[1] However, there is more to it than that, and to fully understand your paycheck you need to know the positive effects that your heath insurance premium payments have on your payroll-related calculations.
Health insurance premium contributions reduce your FICA (or payroll) taxes
If your employer deducts your health insurance premiums directly from your paycheck (as opposed to you writing a check to pay for health insurance) then it saves you taxes by lowering your FICA wage base. Note that Social Security and Medicare taxes combined together are known as “FICA” or “payroll” taxes. A comprehensive example of how to calculate your taxable FICA wages, as well as how health insurance premiums fit into that. However, just focusing on health insurance for now, here is an illustration of how your employee-sponsored health insurance premiums reduce your FICA taxes.[2]
What this example shows is, all things being equal, if your health insurance premiums are deducted from your paycheck then it will lower your taxable FICA wages by $350, and will result in a FICA tax savings of $19.77 a month (or $237.24 a year).
Health insurance premium contributions save you even more on income taxes
Following the principles above relating to FICA taxes, employer-sponsored health insurance contributions also result in substantial savings on your Federal and state income taxes, which is illustrated as follows.[3]
Based on these figures, being able to purchase health insurance through your employer would lower your income tax base by $350, and that would save you $73.50 a month (or $882.00 a year) in income taxes.
Summary
Having health insurance premiums deducted from your paycheck saves you a substantial amount in taxes. Why? Because it because it reduces your taxable wage base before FICA, Federal and state income taxes are applied. Based on the figures in the examples above, your combined FICA and income tax savings would be $93.28 a month ($19.78 plus $73.50) or $1,119.36 a year ($93.28 x 12 months).[4] That’s a substantial amount of money for a regular person! As a result, in evaluating your overall financial situation it’s very important to not only consider the availability of health insurance through your employer, but to take into account the tax-related benefits of health insurance contributions as well.
[1] The average annual cost of family health insurance premiums in 2010 was $13,770. Of that, employees had to cover approximately 27%, or $3,718. That averages out to be about $310 a month, which I have rounded up to $350 due to the higher cost of health insurance in many parts of the country. For reference, see http://ehbs.kff.org/?page=charts&id=1&sn=6&p=1 and http://www.consumerhealthratings.com/index.php?action=showSubCats&cat_id=179.
[2] The FICA tax rate of 5.65% is based on the 2011 Social Security tax rate of 4.2% plus the Medicare tax rate of 1.45%. As of this writing the 4.2% Social Security tax rate is slated to expire at the end of 2011 when it will go back to 6.2%, but it’s not yet clear whether the law will be extended, modified, or allowed to expire.
[3] The 21% tax rate assumes a 15% Federal tax rate and a 6% state tax rate.
[4] Looking at this another way, the net cost of your health insurance wasn’t $350, but $256.73 (the $350 premium less tax savings of $93.28).