November 1, 2021
Comparing pre-tax and taxable wellness benefits
Wellness benefits – from HSAs to gym reimbursements and everything in between – are an increasingly popular aspect of compensation packages. In order to compete effectively, HR and Finance Teams must understand how wellness benefits work from a compliance and implementation standpoint.
Generally speaking when it comes to wellness benefits, the more modern options with better user experiences tend to come with increased tax liabilities whereas the more stodgy and regulated options are tax advantaged.
Below, we break down the basics and provide resources to learn more.
Taxability of wellness benefits
To begin, there isn’t actually a universally-accepted definition for “wellness” benefits. In fact, from the IRS’ perspective, there’s no such thing as a “wellness benefit.” Purchases we might colloquially associate with wellness really spans multiple tax categories:
- Pre-tax: Typically involving strict rules and qualified vendors for administration, employees can invest pre-tax dollars into important quality of life areas from commuting to health to retirement. Pre-tax benefits include HSAs, FSAs, Commuting, 401(k)s, and a number of others.
- Non-taxable: Businesses are allowed to ‘expense’ certain purchases that benefit employee wellbeing, from professional learning and development to allowed work from home subsidies.
- Taxable: Any purchase that isn’t part of a formal pre-tax program or designated as a legitimate non-taxable expense is by definition taxable. This includes some health-related purchases that companies or employees may assume are tax exempt, but aren’t, such as gym reimbursements.
Many companies offer dynamic wellness benefits programs that encompass all three tax categories. For example, imagine that you create a program that includes dependent care assistance, gym reimbursements, and a conference stipend. Voila! You suddenly combined pre-tax, taxable, and non-taxable benefits as part of your program. To learn more, read our guide about taxability of wellness benefits purchases.
Pros and cons
As mentioned earlier, creating a great wellness benefits program isn’t as simple as minimizing tax liabilities. The most modern and attractive options come with increased tax liabilities, so it’s important to offer a mix that’s right for your workforce.
Here’s a brief overview of the factors and tradeoffs to consider:
- Flexibility: The upside of pre-tax benefits is that they are tax advantaged. The downside is that because of the extent of regulations, the “fine print” can be quite exhausting. For example, programs may require employees to use a designated debit card for purchases or upload receipts afterward. They may also require employees to predetermine their contributions ahead of actual spending. These requirements tend to lower employee utilization despite the tax benefits.
- Seamlessness: Because of the regulations, pre-tax benefits often lead to endless questions and inquiries from employees (e.g. “Can I use my commuter card for my Uber home?). Taxable benefits are unregulated and therefore much more straightforward.
- Adaptability: There is virtually no customization available for pre-tax benefits. There are a few select vendors available and the configuration is highly regulated and rigid. With regard to taxable wellness benefits, endless customizability and options are available.
With the above factors in mind, the best employers offer a combination of benefits that span taxability categories while making abundantly clear to employees the ramifications of each. Below, we’ll show you a comparison of approaches and the underlying technologies and ramifications.
- For taxable but modern wellness benefits that employees use and appreciate, your options range from marketplaces to prepaid cards to card-linked.
- For pre-tax benefits that are relatively easy to administer, check out Betterment for 401(k)s and Wex for HSAs, FSAs, and Commuter cards.
Manually-administered stipends and spot bonuses can be a good starting point, but tend not to scale well. Migrating to a wellness benefits solution will enable you to achieve a much higher ROI.