Supplemental health benefits offered by employers can offer benefits beyond major medical insurance to help cover expenses like deductibles, copayments or other unexpected costs. However, unlike traditional health insurance, these benefits aren’t always received tax-free. Knowing what benefits qualify as taxable income can save you from surprises when tax season comes around.

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What are supplemental health benefits?

Supplemental health benefits are policies that provide benefits for specific medical events and conditions. Common examples include:

  • Critical illness insurance: Provides benefits following a range of diagnoses that can affect a person's quality of life, including cancer, heart attacks, strokes and others.
  • Accident insurance: Provides benefits to help cover out-of-pocket costs related to accidental injuries.
  • Hospital indemnity insurance: Provides a fixed daily benefit for each day of a hospital stay to help cover out-of-pocket expenses.
What are taxable benefits?

A taxable benefit1 is any form of compensation or perk provided by an employer or received through an insurance policy that is subject to income tax. Whether a benefit is taxable depends on how the premiums (payments to the insurer to keep your insurance policy active) are paid:

  • Employer-paid premiums: If your employer pays the premiums and does not include them in your taxable income, any benefits you receive are generally taxable.
  • Employee-paid premiums with pretax dollars: If you pay premiums via payroll deductions on a pretax basis, the IRS treats these premiums as employer-paid. These benefits received are generally taxable.
  • Employer- and employee-paid with pretax dollars: If you and your employer both contribute to the premiums with pretax dollars, the benefits received are generally taxable.
  • Employee-paid premiums with after-tax dollars: If you pay the premiums with after-tax dollars, benefits received are generally not taxable.

If a benefit is considered taxable, its value must be included in your gross income2 and reported to the IRS, potentially increasing your tax liability. While we’ve focused on federal income tax, note that state income taxes may also apply. Consult a tax advisor for the tax implications in your state of residence.

Examples of how supplemental benefits are taxed

These examples are for illustrative purposes only and are meant to provide a general overview of how your supplemental health benefits may be taxed. Any resemblance to actual persons is purely coincidental.

These scenarios illustrate how benefits were paid and taxed for different individuals based on their benefits selections:

Maria the retail manager
  • Critical illness insurance with premiums fully paid by employer: When Maria was diagnosed with a qualifying illness, she was grateful to receive a lump-sum benefit from her critical illness insurance policy to help pay some of her medical expenses. The money she received was taxable because her employer had fully paid the premiums.
  • Accident insurance with premiums deducted pretax from paycheck: Later that year, Maria was injured in an accident. Her accident insurance helped her with the unexpected expenses. The benefits were taxable, because the premiums were deducted from her paycheck on a pretax basis.
  • Hospital indemnity insurance with premiums paid using after-tax dollars: Finally, during a hospital stay, Maria’s hospital indemnity insurance provided additional benefits that helped offset costs that weren’t covered by her primary insurance. The benefits were not taxable, because Maria had paid the premiums herself with after-tax dollars.
Lisa the engineer
  • Hospital indemnity insurance fully paid by employer: After an unexpected hospital stay, Lisa’s hospital indemnity insurance provided much-needed financial assistance. The benefits were taxable, since her employer had fully funded the premiums without including the cost in her taxable wages.
  • Accident insurance with premiums paid with after-tax dollars: On a separate occasion, Lisa suffered a minor injury and used her privately purchased accident insurance for support with expenses. This time, the payout was not taxable, as she had purchased the policy independently using her own after-tax dollars.

These examples show why it’s important to understand the tax treatment of your supplemental health benefits. Remember, employer and/or employee-paid premiums with pretax deductions often result in taxable benefits, while after-tax contributions are generally non-taxable benefits. Knowing how your premiums are paid can help you anticipate tax obligations, avoid surprises, and make informed decisions to maximize the value of your supplemental health benefits.

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