Section 105 for Dummies

There seems to be a pattern of misunderstanding in some areas about I.R.C. Section 105 and its application in the employer sponsored health insurance market. Some folks seem to tout the virtues of 105 for its ability to lower benefit costs without acknowledging the flip side to their argument.

That would be the total or partial exclusion of employees and/or their dependents from participating in such a benefit plan.

But I am getting the cart before the horse . . .

Section 105 refers to a portion of the Internal Revenue Code which allows an employer to establish a welfare benefit plan for the employees and do so on a tax-favored basis. Some of the items that can be offered through a 105 plan include coverage for OTC meds, health & dental insurance premiums and coverage for out of pocket expenses such as deductibles & copays.

Most employers are aware they can purchase group health insurance, pay for it with before tax dollars, and deliver it to their employees on a tax favored basis. But many may not know they can do likewise with individual coverage and enjoy many of the same tax benefits.

The real benefit to the employer about 105 plans is their ability to set up a benefit plan on a Defined Contribution basis. Most employer plans are now structured as Defined Benefit plans where the employer chooses the benefits to be offered and the carrier quotes a price.

DC (defined contribution) plans work the opposite. The employer indicates they are willing to spend a pre-determined dollar amount on benefits and the employee is free to choose how they want those dollars to be spent. Some employees may want health insurance, others dental, and others only want coverage for out of pocket expenses.

This makes the DC plan extremely flexible and tailored to the needs of both the employer (limiting their outlay) and the employee (ability to choose benefits most wanted).

But it also makes coverage for some employees challenging in the least and unobtainable at the worst.

Group insurance carriers require a certain level of employer contribution as well as participation levels before they will issue a contract. By its’ very nature, group insurance cannot restrict coverage for employees with pre-existing conditions (and prior creditable coverage) and must accept all regardless of their health or future medical costs. An example of this is a recent client.
I was approached about finding cover for a lady with MS (multiple sclerosis) and an accompanying $1800 a month “habit” for meds that kept her condition in remission for the past 20 years. She was losing her COBRA and there was not an individual carrier to be found that would issue cover.

Group insurance comes to the rescue! She works for a business (owned by her fiancée) so I was able to secure coverage for her at an affordable $400 a month which includes $30 copays for her meds.

Such a deal!

In this case (and others like it) a Section 105 plan funded with individual policies was not an option. While this is an extreme example, it still points to the folly of suggesting the 105 is a panacea for business owners. Individual polices are almost always less expensive than group plans with similar benefits and that is a nice feature. But when the individual policy route conflicts with an employers desire to cover certain workers, the plan goes down in flames.

The real benefit of 105 plans is not so much the way the benefits are provided (individual policies vs. group policies) but the fact the employer has much more control over expenditures for the plan by establishing a budget. Using individual policies under a 105 plan is great for the writing agent because the compensation is 3x to 4x what it would be under a group insurance plan. But that same approach is also self defeating when an employer genuinely wants to provide a benefit plan for all employees, or even a select group of employees.