August 28, 2024

Yes, employers are generally permitted to offer taxable cash incentives to employees who waive group health coverage under the employer’s Section 125 cafeteria plan. The details of the opt-out arrangement should be specified in the cafeteria plan document and clearly communicated to employees in the annual enrollment materials.

However, there are several compliance issues to consider with an opt-out arrangement.

First, for an applicable large employer (ALE) with 50 or more full-time or equivalent employees in the prior year, the design of the opt-out arrangement can affect their affordability calculation under the ACA employer mandate. To review, an ALE must offer affordable, minimum value coverage to full-time employees to avoid potential penalties. “Affordable” means that the employee cost for the least expensive single tier coverage must not exceed 8.39% (for plan years beginning in 2024 but indexed annually) of the employee’s household income, as determined according to the applicable safe harbor (i.e., rate of pay, W-2, or federal poverty line) chosen by the employer.

If the opt-out arrangement allows an employee to waive the group medical coverage unconditionally (i.e., regardless of whether the employee has other minimum essential coverage (MEC)), the employee’s coverage cost for affordability purposes would include the opt-out payment. Accordingly, from the employer’s perspective, the opt-out payment would negatively impact the ACA affordability calculation.

By contrast, if an employer requires the employee to provide reasonable evidence, such as an attestation, that the employee and their tax family (i.e., family members for whom the employee expects to claim a tax exemption) have other MEC that is NOT individual market coverage to receive the opt-out payment, then it’s considered a conditional or “eligible” opt-out arrangement. The other MEC coverage could be, for example, coverage under the group health plan of a spouse or parent. Additionally, an IRS official has informally indicated that other MEC would include coverage under Medicare or TRICARE. With an eligible opt-out, the cash payment is not added to the employee’s contribution when performing the affordability calculation, making it easier for the employer to satisfy ACA affordability requirements.

Second, the employer would generally want to offer opt-out benefits to all eligible employees, to avoid violating nondiscrimination rules. For example, the HIPAA nondiscrimination rules prohibit discrimination based on a health factor and singling employees out for a payment on this basis. The Section 125 nondiscrimination rules apply to cafeteria plan benefits and prohibit discrimination that favors key or highly compensated employees. Additionally, for employers with over 20 employees, the Medicare Secondary Payer rules would prohibit incentivizing only Medicare-eligible employees to opt out of the employer’s plan to enroll in Medicare.

Third, the employer would need to consider the amount and timing of the opt-out payments. The cash-out amount is typically a fraction of the actual cost of the coverage, and thus is less likely to be viewed as aggressive encouragement by the employer to drop the group coverage. Additionally, the employer may prefer to spread the payments over the plan year; this approach alleviates the situation where an employee receives an up-front lump-sum incentive for declining coverage and quits after a few months. Furthermore, an employee who waives coverage may still have a HIPAA special enrollment opportunity later in the plan year (e.g., due to a loss of other coverage or a new dependent).

Fourth, since the opt-out payment is considered taxable compensation, the employer may want to review any impact on wages or the calculation of overtime compensation, as applicable, with their employment law counsel or payroll advisor.

Finally, it’s generally advisable for the employer to check with their insurer or stop-loss carrier before offering an opt-out payment to ensure such an arrangement is consistent with any insurance requirements and/or contract terms.

For further information on opt-out arrangements and other cost-share contribution considerations when offering group health coverage, please download a copy of the PPI publication Cost-Share Contribution Models: A Guide for Employers.