What Is a Premium Only Plan (POP)?
If you offer group health insurance but haven’t set up a Premium Only Plan, you’re quietly overpaying on payroll taxes every single pay period. So are your employees. The fix takes a few days, costs you nothing to maintain, and saves everyone money immediately.
A Premium Only Plan (POP) is the simplest type of Section 125 cafeteria plan. It does one thing: it allows employees to pay their share of health insurance premiums — medical, dental, and vision — with pre-tax dollars. That’s it. No flexible spending accounts, no dependent care accounts, no complicated administration. Just a straightforward mechanism that converts after-tax premium payments into pre-tax deductions.
How a Premium Only Plan Works
The mechanics are simple. Without a POP, here’s what happens:
- Your employee earns their gross pay
- All taxes are calculated and withheld on the full amount
- The employee pays their health insurance premium from what’s left
With a POP in place:
- Your employee earns their gross pay
- Their health insurance premium is deducted before taxes are calculated
- Taxes are calculated on the reduced amount
That difference — calculating taxes on a lower number — is where the savings come from. The employee’s premium payment avoids federal income tax, Social Security tax (6.2%), Medicare tax (1.45%), and in most states, state income tax.
A Quick Example
Take an employee earning $50,000 per year who pays $300/month ($3,600/year) for health insurance premiums.
Without a POP:
- Taxable wages: $50,000
- Employee pays $3,600 in premiums from after-tax income
- At a ~30% combined tax rate, taxes on that $3,600 = $1,080 wasted
With a POP:
- Taxable wages: $46,400 ($50,000 minus $3,600)
- Employee saves roughly $1,080/year in taxes
- Employer saves 7.65% FICA on $3,600 = $275/year per employee
Multiply those employer savings across your workforce, and the numbers add up fast. A company with 20 employees could easily save $5,000–$8,000 per year in employer FICA taxes alone.
Who Qualifies to Set Up a POP?
If you meet these two conditions, you can establish a POP:
- You’re an employer with W-2 employees. Any business entity — C-corp, S-corp, LLC, nonprofit, or government entity — qualifies.
- You offer group health insurance. If employees pay any portion of their health, dental, or vision premiums, a POP creates immediate tax savings.
There’s no minimum company size. Whether you have 3 employees or 300, you’re eligible.
Who Can’t Participate
A few categories of individuals cannot participate in their own POP:
- Sole proprietors — you can set up a POP for your employees, but you can’t participate yourself
- Partners in a partnership — same rule
- More-than-2% S-corp shareholders — the IRS treats your benefits differently
Your W-2 employees, however, are fully eligible regardless of your business structure.
The Setup Process (Easier Than You Think)
Setting up a POP is surprisingly straightforward. Most businesses can have one running within two to four weeks. Here’s what’s involved:
Step 1: Create a Plan Document
Every Section 125 plan — including a POP — requires a written plan document. This document outlines:
- The benefits covered (in this case, health insurance premiums)
- Employee eligibility rules
- How and when elections are made
- The plan year dates
You can get a plan document through your benefits administrator, a third-party administrator (TPA), payroll provider, or even some insurance brokers. Many payroll companies include POP plan documents as part of their service.
Step 2: Distribute the Summary Plan Description
Employees need a summary of how the plan works and what their rights are. This is usually a one- or two-page document written in plain language.
Step 3: Collect Employee Elections
Before the plan year begins, each employee signs an election form choosing to have their premiums deducted pre-tax. This is typically done during open enrollment alongside their health insurance enrollment.
Step 4: Update Payroll Coding
Coordinate with your payroll provider to ensure premium deductions are coded as pre-tax Section 125 deductions rather than after-tax deductions. This is where the actual savings happen — if the deduction isn’t coded correctly, the tax benefit doesn’t apply.
Step 5: You’re Done
That’s genuinely it. There are no IRS filings required to establish the plan. No annual Form 5500 for a POP-only plan (unless it includes other benefits that trigger the filing requirement). No complex administration.
What Does a POP Cost the Employer?
Here’s the best part: effectively nothing. In fact, a POP saves you money from day one.
Direct Costs
- Plan document: $0–$500 one-time, depending on whether your payroll provider includes it or you use a TPA
- Annual administration: $0–$300/year — many payroll services include POP administration at no extra charge
- Nondiscrimination testing: Generally simpler for POP-only plans, and often included in TPA fees
The FICA Savings Math
Here’s where the ROI becomes obvious. Your employer FICA rate is 7.65% (6.2% Social Security + 1.45% Medicare). Every dollar your employees deduct pre-tax for premiums reduces your FICA obligation by 7.65 cents.
| Employees | Avg. Annual Premium | Total Pre-Tax Deductions | Annual Employer FICA Savings |
|---|---|---|---|
| 10 | $3,600 | $36,000 | $2,754 |
| 25 | $3,600 | $90,000 | $6,885 |
| 50 | $3,600 | $180,000 | $13,770 |
| 100 | $3,600 | $360,000 | $27,540 |
Even a 10-person company saves nearly $2,800 per year. That’s money that was going to the government for no reason.
Compliance Requirements
One of the biggest advantages of a POP is that its compliance burden is much lighter than a full cafeteria plan with FSAs.
What You Need to Do
- Maintain a written plan document — keep it on file and update it if your benefits change
- Hold annual enrollment — employees must make their elections before the plan year begins
- Conduct nondiscrimination testing — the IRS requires that POPs don’t disproportionately favor highly compensated employees, but testing for a POP-only plan is simpler than for a full cafeteria plan
- Follow the irrevocability rule — once employees elect pre-tax premiums, they can’t change mid-year unless they have a qualifying life event (marriage, birth of a child, loss of coverage, etc.)
What You Don’t Need to Do
- No Form 5500 filing for most POP-only plans
- No FSA claims processing — there are no reimbursement accounts to manage
- No use-it-or-lose-it concerns — premiums are a fixed cost, so there’s nothing to forfeit
- No debit cards to issue — employees just see the deduction on their paycheck
Common Misconceptions
”Isn’t this automatic? Don’t premiums come out pre-tax already?”
No. This is the most common misconception about pre-tax benefits. Just because an employee’s premium is deducted from their paycheck does not mean it’s deducted pre-tax. Without a formal Section 125 plan document in place, those deductions are after-tax by default.
Check with your payroll provider. If you never set up a POP or Section 125 plan, there’s a good chance your employees are paying premiums with after-tax dollars right now — and you’re both paying unnecessary FICA taxes.
”We’re too small for this.”
There’s no minimum size requirement. If you have even one W-2 employee paying a share of health insurance premiums, a POP creates savings. Some of the highest-ROI implementations are at companies with 5–15 employees.
”This sounds too good to be true.”
It’s been part of the tax code since 1978. Section 125 isn’t a loophole or a gray area — it’s an explicit provision of the Internal Revenue Code designed to encourage employers to offer benefits. The IRS expects employers to use it.
”Won’t this reduce my employees’ Social Security benefits?”
Technically, lower taxable wages mean a slightly lower wage base for Social Security benefit calculations. In practice, the reduction is negligible for most employees, and the immediate tax savings during working years almost always outweigh any marginal impact on future benefits.
POP vs. Full Cafeteria Plan
A POP is the starting point. If you want to offer employees more pre-tax options beyond premium deductions, you can upgrade to a full cafeteria plan that includes Health FSAs, Dependent Care FSAs, HSA contributions, and other qualified benefits. Learn more about Types of Cafeteria Plans.
| Feature | POP | Full Cafeteria Plan |
|---|---|---|
| Pre-tax health premiums | Yes | Yes |
| Health FSA | No | Yes |
| Dependent Care FSA | No | Yes |
| HSA contributions | No | Yes |
| Administration complexity | Low | Moderate |
| Typical cost | $0–$300/year | $500–$2,000/year |
| Nondiscrimination testing | Simpler | More involved |
Many businesses start with a POP and add FSAs or other benefits as they grow. There’s nothing wrong with starting simple.
How to Get Started
If you offer group health insurance and don’t have a POP in place, you’re leaving money on the table today. Here’s what to do:
- Check your current setup — Ask your payroll provider whether your premium deductions are coded as pre-tax Section 125 deductions. If not, you need a POP.
- Estimate your savings — Use our FICA Savings Calculator to see exactly how much your company could save based on your headcount and premium amounts.
- Contact your payroll provider or a TPA — Many can set up a POP in two to four weeks, and some include it at no additional cost.
The plan document must be in place before the plan year begins, so don’t wait until December if you’re on a calendar-year plan. But if you’re mid-year, you can start a short plan year on any date.
The bottom line: A POP is the easiest, cheapest, most impactful benefits decision most small businesses can make. It costs nothing, saves everyone money, and takes a few weeks to set up. If you’re not doing it, start now.
This guide is for informational purposes and does not constitute tax or legal advice. Consult with a qualified tax professional or benefits advisor for guidance specific to your situation.
