Employee Benefits Question of the Week: Medical Opt-Out Payments

QUESTION: What is a medical opt-out payment?

ANSWER:   Many employers offer employees the option to use the employer’s cafeteria plan to opt-out of group health plan coverage and receive taxable cash payments. It is important that employers consider the possible ramifications such opt-out payments may have on employees and their benefits.


Most opt-out payments are significantly less than the amount the employer saves. Typically, opt-out payments are spread out over the plan year, and are not paid in a lump sum, which allows the employer to reduce its risk of loss in the event an employee terminates employment or experiences a HIPAA special enrollment event.


Opt-out payments are taxable to the employee. The cash payments must be included in gross income on the employee’s Form W-2 and are subject to federal income tax withholding. These payments are also generally subject to federal employment tax withholding (FICA and FUTA). Because opt-out payments give employees a choice between health care coverage and taxable compensation, they must be offered through a cafeteria plan under Section 125 of the Internal Revenue Code.

ACA Affordability Calculation Impact

To avoid potential penalties under the shared responsibility rules, ALEs must offer affordable, minimum value health coverage to substantially all full-time employees. In general, the affordability of an employer’s offer of health coverage depends on whether the employee’s required contribution for self-only coverage exceeds a certain percentage of the employee’s household income.

The IRS’ guidance groups medical opt-out arrangements into two general categories:

  • Unconditional medical opt-out payments –opt-out payments are conditioned solely on an employee declining coverage under an employer’s health plan and not on an employee providing proof of other coverage. According to Notice 2015-87, it is generally appropriate to treat unconditional opt-out payments as increasing an employee’s contribution for health coverage beyond the amount of the employee’s salary reduction contribution.

For example, an employee whose required self-only contribution for health coverage is $200 per month, but who is eligible for a cash payment of $100 per month if coverage is waived would be treated as having a required contribution of $300 per month when determining if the coverage is affordable. Until the proposed regulations are finalized, this guidance applies to unconditional opt-out arrangements that are adopted after Dec. 16, 2015.

  • Conditional medical opt-out payments – An arrangement where the opt-out payments are conditioned on an employee declining coverage under an employer’s health plan and providing proof of other coverage. An eligible opt-out arrangement is one where the opt-out payments are available only to employees who decline employer-sponsored coverage and provide reasonable evidence that they and their expected tax dependents have or will have minimum essential coverage other than individual market coverage during the plan year. Payments under conditional opt-out arrangements will not be treated as increasing an employee’s required contribution until the proposed regulations are finalized.

Other Legal

  • Offering opt-out incentives only (or primarily) to employees who have a history of high health claims may violate nondiscrimination rules under the Health Insurance Portability and Accountability Act (HIPAA).
  • Opt-out incentives may violate the Medicare Secondary Payer rules for employers with Medicare-eligible employees (or employees who are married to Medicare-eligible persons).
  • consider how opt-out incentives may impact the calculation of overtime payments under the Fair Labor Standards Act (FLSA). The opt-out incentives may need to be factored into employees’ regular pay when calculating overtime payments, depending on the facts of the specific opt-out incentive arrangement.


Source: Zywave search “Medical Opt-out Payments”

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