Federal Employees Can Elect to Waive 'Premium Conversion'Participation During Open Season

Each year during the benefits “open season”, employees and annuitants make decisions regarding which health, dental and vision insurance plans they want to be covered by during the upcoming plan year that starts in early January. Another decision with respect to their health insurance plans that employees have to make is whether they want to continue participation in “premium conversion.” This column is the second of eight columns discussing choices that employees and annuitants have to make during the upcoming benefits “open season” which runs from Nov. 11 through Dec. 9, 2019 and presents the advantages and disadvantages of “premium conversion.”

What is “Premium Conversion”?

“Premium conversion”” is an arrangement in which employees (but not annuitants) pay their health insurance premiums with “before-taxed” salary dollars. “Before taxed” salary means before all taxes - this includes Federal and state income taxes (most states), Social Security (FICA) and Medicare Part A (hospital insurance) payroll taxes - are deducted from an employee’s gross salary to pay the health insurance premiums due each pay date. The following example illustrates:

Francine is enrolled in the Federal Employees Health Benefits (FEHB) program (self and family coverage) and pays $500 in premiums each pay date for her FEHB health insurance plan. The $500 is deducted from Francine’s gross salary to pay the premium due. Assuming Francine is in a 24 percent federal tax bracket and in an 8 percent state income tax bracket, Caroline pays the following amount in total taxes by having the full $500 deducted from her gross salary to pay the premium due:

24 percent (federal tax bracket) plus 8 percent (state tax bracket) plus 6.2 percent (FICA payroll tax)                  
plus 1.45 percent (Medicare Part A payroll tax)
equals 39.65 percent
39.65 percent of $500 equals $198.25
Over 26 pay dates (one year) Caroline is saving 26 times $198.25, or $5,154, in total taxes through participation in “premium conversion”.

Note that the FEHB Insurance premiums deducted under “premium conversion” are not subject to either income (Federal and state) or payroll (Social Security - FICA and Medicare Part A - hospital insurance) taxes. This is somewhat different than traditional Thrift Savings Plan (TSP) contributions in which the employee’s contributions are deducted from the employee’s gross salary - before Federal and state income taxes - but after Social Security and Medicare Part A payroll taxes are withheld, and the employee pays Federal and state income taxes upon withdrawing the traditional TSP account.

Employees who enroll in the FEHB program and in the dental and/or vision insurance offered through the Federal Employees Dental and Vision Insurance Program (FEDVIP) are automatically enrolled in “premium conversion”. Under IRS rules, annuitants are not allowed to participate in “premium conversion”. Annuitants who are enrolled in the FEHB program and the FEDVIP by law must have their premiums deducted from their after-taxed annuities. Their CSRS and FERS annuities are not subject to FICA and Medicare Part A payroll taxes and, in several states, not subject to state and local income taxes. 

Employees have the option of waiving “premium conversion” with respect to their FEHB program premiums. They do not have the option of waiving “premium conversion” with respect to their dental and vision insurance premiums under the FEDVIP. The question then becomes: Why would an employee want to waive “premium conversion” for their FEHB program premiums and forgo the associated tax savings? Possible reasons include: (1) flexibility; (2) include the FEHB program premiums as a medical expense itemized deduction; and (3) effect on future Social Security retirement benefits. These reasons are now discussed.

Flexibility. An employee participating in “premium conversion” generally has all the same flexibility as an employee who chooses not to participate. But tax laws give two exceptions. If an employee waives “premium conversion”, then the employee will have the flexibility to either drop his or her FEHB insurance altogether or change from “self and family” or “self plus one” enrollment to “self only” enrollment at any time of the year without giving any reason. An employee who participates in “premium conversion” will be allowed to drop FEHB coverage, or to change to “self only”, enrollment only during an “open season” or if the employee experiences a “qualifying life event” such as marriage or the employee’s spouse has a job in which the spouse enrolls in the job’s group health insurance plan. But this flexibility is generally of little or no value compared to the tax savings associated with “premium conversion”.

    • Including FEHB health insurance premiums as itemized medical expenses on Schedule A. By being enrolled in premium conversion, an employee is not permitted to include the FEHB premiums deducted from their gross salaries as medical expenses on Schedule A of their federal income tax returns, assuming the employee itemizes on his or her Federal income tax return. In order for an individual to deduct their out-of-pocket medical, dental and vision expenses, the total expenses would have to exceed 10 percent of the individual’s adjusted gross income (AGI). Most employees will not to have enough in out-of-pocket medically-oriented expenses in order to deduct these expenses. By including the FEHB premiums as part of their out-of-pocket medical expenses, an employee’s out-of-pocket medical, dental and vision expendes could exceed the 10 percent of theAGI threshold. But for employees who do not itemize on their Federal income taxes and instead take the standard deduction, “premium conversion” results makes complete sense.

Effect on future Social Security benefits. As previously mentioned, “premium conversion” means paying one’s FEHB health insurance and FEDVIP dental and vision premiums with “before-taxed” dollars, including FICA (Social Security). Each year, an employer reports employee Social Security wages (shown in Box 3 – “Social Security Wages” -  of the employee’s W2) to the Social Security Administration. Participation in “premium conversion” therefore results in lower Social Security wages for a participating employee. Since the Social Security Administration determines an individual’s future Social Security retirement benefits based on the individual’s 35 highest years of Social Security earnings, participating in “premium conversion” could result in a slightly lower Social Security retirement benefit when the individual files for that benefit. The extent of benefit reduction will depend on: (1) The employee’s retirement system. CSRS employees (who are not covered by Social Security) need not be concerned while CSRS Offset and FERS employees who do pay into Social Security are affected; (2) the employee’s salary compared with the Social Security maximum wage base ($132,900 during 2019); and (3) the number of years the employee has until retirement.

How “Premium Conversion” is Waived?

During the FEHB “open season”, employees have the opportunity to elect or waive their participation in “premium conversion”. An “open season” election to participate or waive participation in “premium conversion” must be received by an employee’s employing agency no later than the last day of the “open season”. The effective date of the elective is the same as the effective date of a FEHB election which is the first payroll period that begins on or after January 1st.

This year’s “open season” dates are Nov. 11, 2019 through Dec. 9, 2019. The start of the first payroll bi-weekly pay period at most agencies after Jan. 1, 2020 will be Jan. 5, 2020. This means that employees who wish to enroll or waive participation in premium conversion must do so no later than close of business on Dec. 9, 2019, with an effective date of Jan. 5, 2020.

Employees should contact someone in their Personnel or Human Resources Office for the necessary paperwork and forms required to elect or to waive “premium conversion.”

A table of permissible changes in FEHB enrollment and “premium conversion” election may be downloaded at www.opm.gov/healthcare-insurance/healthcare/reference-materials/reference/federal-employees-receiving-premium-conversion-tax-benefits/.

Edward A. Zurndorfer is a Certified Financial Planner, Chartered Life Underwriter, Chartered Financial Consultant, Certified Employee Benefits Specialist, Registered Health Underwriter 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, located at 833 Bromley Street - Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. 

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