Premium Only Plan (POP)
Summary Definition: A benefit plan allowing workers to use pre-tax wages to pay monthly insurance premiums.
What is a Premium Only Plan?
A premium only plan (POP) is a type of Section 125 cafeteria plan that allows employees to pay their share of employer-sponsored health insurance premiums using pre-tax dollars. These plans typically cover premiums for medical, dental, vision, and certain life insurance policies.
As a standard cafeteria plan option, POPs help streamline pre-tax benefit contributions, promoting cost-efficiency in health plan management. In some instances, employers may instead offer a "cash-in-lieu" option for employees who opt out of coverage, though this benefit is subject to taxation.
Unlike other cafeteria plans, where enrollees can spend allocated funds on a wide range of eligible purchases, premium only plans restrict the use of funds to monthly insurance premiums.
Key Takeaways
- Premium only plans allow employees to set aside pre-tax income to pay for monthly insurance premiums.
- POPs help employees and employers reduce tax liabilities but can’t be offered to highly compensated employees or certain key employees, such as officers or owners.
- As a Section 125 Cafeteria plan, POPs must meet specific compliance criteria, such as providing necessary plan documentation and passing nondiscrimination testing.
What is a Section 125 Cafeteria Plan
Under Section 125 of the Internal Revenue Code (IRC), cafeteria plans are employer-sponsored benefit arrangements allowing workers to choose between taxable and non-taxable benefits. Other types of Section 125 plans include:
- Full Flex Cafeteria Plan: Employees use employer contributions to select benefits that meet their needs. Any benefits not fully covered by employer funds can be paid for with voluntary payroll deductions.
- Simple Cafeteria Plan: A condensed version of standard cafeteria plans for employers with 100 or fewer employees. Typical nondiscrimination tests are bypassed with this plan as the workforce’s small size makes uniform employer contributions easier.
- Health Savings Account (HSA): Specialized savings accounts that allow employees to set aside and use pre-tax income for qualified medical expenses
- Flexible Spending Account (FSA): Specialized spending accounts that also allow employees to set aside and use pre-tax income for qualified expenses
- Dependent Care Assistance Plan (DCAP): A type of FSA employees can use to cover the cost of caring for children under 13, elderly parents, or individuals living with them who can’t care for themselves.
Why Offer a Section 125 Premium Only Plan?
Allowing workers to pay for eligible insurance premiums with pre-tax dollars serves a strategic purpose for both employees and employers. Employees lower their overall income tax liabilities by reducing taxable income through pre-tax contributions, increasing their net earnings.
Employers reap the rewards of reduced payroll taxes, thanks to the lower taxable payroll resulting from these pre-tax contributions. Even small pre-tax contributions per employee can compound into significant savings when multiplied across an entire workforce.
Premium Only Plan Section 125 Rules
POPs must comply with certain rules and regulations established by the Internal Revenue Service (IRS). For example, cafeteria plan participants must be allowed to choose between one taxable benefit and at least one qualified benefit.
Taxable benefits often take the form of cash, though they may also include options like paid time off (PTO) or severance packages. Qualified benefits, conversely, don’t involve deferred compensation and are included in an employee’s gross income, such as adoption assistance or voluntary insurance plans.
Required Documentation
To establish and maintain Section 125 plan compliance, employers must create and adopt plan documentation outlining critical details of the offered benefits. This typically consists of a primary plan document, an adoption agreement, and a summary plan description (SPD).
The primary plan document and adoption agreement provide a comprehensive overview of the offered benefits, including eligibility rules, the scope of qualified benefits, contribution limits, and employer-specific obligations. Employers can combine or keep the two documents separate but must finalize them by the first day of the plan year.
SPDs communicate a plan’s key details to eligible employees in a straightforward, accessible way. Employers must distribute the SPD to eligible employees within 90 days of their enrollment and provide a new, updated copy every five years.
Eligibility and Elections
Any business with employees subject to federal income taxes can sponsor a POP and offer it to current employees, their spouses, and their dependents. Employers can also extend one to former employees, but doing so isn’t required.
Owners and certain key individuals — such as the self-employed, partners in partnerships, and S corporation shareholders with over a 2% ownership stake — are ineligible.
Employees typically select their coverage options during an annual open enrollment period, and these choices take effect on the first day of the following plan year. New hires, however, can make retroactive elections within 30 days of their start date, making coverage effective as of their hire date.
Elections are usually irrevocable during the plan year, but exceptions are allowed for certain qualifying events, such as marriage or the birth of a child.
Nondiscrimination Testing
POPs are subject to nondiscrimination testing to ensure the plans don’t favor key individuals or highly compensated employees (HCEs) at the expense of other employees. Tests must be conducted annually to maintain compliance with Section 125 and avoid penalties or punishments. The three test types include:
| Test | Purpose | Criteria |
| Eligibility Test | Ensures the plan is offered broadly and fairly to all eligible employees | POPs must use consistent eligibility criteria for all employees (with limited exceptions), and any waiting period to enroll in the plan must be three years or less. |
| Contributions and Benefits Test | Verifies contributions and benefits aren’t skewed toward HCEs* | HCE contributions and benefit allocations must be proportionally equal to or less favorable than those for non-HCEs. |
| Key Employee Concentration Test | Assesses if key employees receive a disproportionate share of pre-tax benefits** | No more than 25% of the total pre-tax benefits can be allocated to key employees, as defined by factors such as ownership stakes or specified compensation levels. |
*Includes officers, individuals who own more than 5% of company stock, and employees earning above an annually updated compensation threshold.
**Includes officers earning above a different annually updated compensation threshold who own at least 5% of the company.
Premium Only Plan Pros and Cons
In addition to tax savings, a Section 125 POP allows workers to tailor benefits to their needs. This helps companies address a diverse workforce’s expectations and lifestyles, improving employee satisfaction.
Like FSAs, however, unused POP funds are forfeited at the plan year's end, and employers often face fees for establishing and maintaining a POP.
Moreover, some plans may necessitate hiring benefit specialists to guarantee compliance and avoid penalties. Employers can minimize these operational costs by working with an HRIS partner that offers robust benefits administration tools and solutions.
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