# Section 125 tax savings calculator

Source: https://www.getprescience.com/tools/section-125-tax-savings-calculator
Author: Rishab Jain, Cofounder and CEO, Prescience
Published: 2026-10-24
Updated: 2026-10-24
Cite as: Rishab Jain. "Section 125 tax savings calculator." Prescience, October 24, 2026. https://www.getprescience.com/tools/section-125-tax-savings-calculator

When employees pay their share of health premiums through a Section 125 plan, that money isn't subject to Social Security and Medicare taxes or, in most states, income tax. The company saves its 7.65% payroll tax on every dollar, and each employee keeps their 7.65% plus their income tax rate. Enter your team's contributions to see both.

- **Employer payroll tax saved:** 7.65% of contributions
- **2026 Social Security wage base:** $184,500
- **Plan needed:** Written cafeteria plan document
- **Typical setup cost:** Low; often included with payroll

## Estimate the savings

_Interactive calculator: open the page in a browser to use it. The rules and figures it applies follow._

Most companies with a group plan already have a premium only plan (POP), often set up by their payroll provider. I've still met plenty of founders who were deducting premiums after tax without knowing it, usually because nobody signed the plan document. This calculator shows what that costs.

## How a Section 125 plan saves taxes

Section 125 of the tax code lets employees choose between cash wages and certain qualified benefits without the benefit being taxed. When an employee elects health coverage through the plan, their premium share is taken from gross pay before taxes are calculated.

**Taxes avoided on pre-tax premium contributions**

| Tax | Employee | Employer |
| --- | --- | --- |
| Social Security (up to the wage base) | 6.2% | 6.2% |
| Medicare | 1.45% | 1.45% |
| Federal income tax | Their bracket (10%–37%) | — |
| State income tax | Most states | — |
| Federal unemployment (FUTA) | — | Often, on the first $7,000 |

The calculator counts only Social Security and Medicare for the employer, which is the reliable part. Unemployment tax savings depend on wages and state rules, so treat them as a bonus.

Pre-tax premiums can also lower the wages that some state payroll taxes and insurance premiums are calculated on, depending on the state and the benefit. State income tax treatment usually follows the federal rule for health premiums, but states differ on other cafeteria plan benefits, so check your state before quoting exact savings to employees. When in doubt, model only the 7.65% federal payroll tax, which applies everywhere and is the number this calculator uses for the company.

## Worked example: a 20-person company

**Average single-coverage contributions, run pre-tax**

Illustrative. 20 employees each pay $1,440 a year (KFF's 2025 single average). Typical federal bracket 12%, state income tax 5%, all pay below the Social Security wage base.

- Total employee contributions: $28,800
- Employer payroll tax saved (7.65%): $2,203.20
- Each employee saves (12% + 5% + 7.65%): $354.96
- Employees save in total: $7,099.20

About $2,200 a year for the company and $355 per employee, for what is mostly a paperwork exercise. With family contributions near KFF's $6,850 average, the numbers are almost five times larger.

## Who benefits most

The savings scale with how much employees contribute, so the payoff is largest where premiums are shared rather than fully paid by the company. If you pay 100% of every premium, a premium only plan saves nothing on medical coverage, because there are no employee contributions to run through it, though it still matters for dental, vision and FSAs.

**Annual savings per employee by contribution level (12% federal, 5% state)**

| Employee premium share per year | Employee saves | Employer saves |
| --- | --- | --- |
| $1,440 (KFF single average) | $355 | $110 |
| $3,600 | $887 | $275 |
| $6,850 (KFF family average) | $1,689 | $524 |

Employees in states with no income tax, such as Texas, Florida and Washington, save a little less, but the 7.65% payroll tax saving applies everywhere.

## Setting up a premium only plan

1. **Adopt a written plan document** Section 125 requires a written plan describing the benefits, eligibility and election rules, adopted before the plan year starts. Payroll providers and benefits administrators usually supply one.
2. **Give employees a summary** Employees need to know what they're electing and that elections are generally fixed for the plan year.
3. **Set up pre-tax deductions in payroll** Mark the medical, dental and vision deductions as Section 125 so they reduce taxable wages on the W-2.
4. **Run nondiscrimination tests** Cafeteria plans can't favor highly compensated or key employees. A plan where everyone pays premiums the same way usually passes easily.

Our guide to [Section 125 and pre-tax health insurance](https://www.getprescience.com/guides/section-125-pre-tax-health-insurance) covers the rules in more depth.

## Common Section 125 mistakes I see

- **No signed plan document.** Payroll marks deductions as pre-tax, but nobody ever adopted the plan. In an audit, the deductions can be treated as taxable wages.
- **Letting people change elections whenever they ask.** Elections are fixed for the plan year except after a qualifying event. Allowing ad hoc changes can disqualify the plan.
- **Including owners.** More-than-2% S corporation shareholders get their premiums added to W-2 wages instead. Running them through the POP is a common payroll error.
- **Forgetting new hires.** New employees need to make an election when they join; until they do, their deductions may default to after-tax.
- **Skipping the annual nondiscrimination test.** It's usually easy to pass, but it has to be done.

None of these are hard to fix. If you're not sure your plan is set up correctly, ask your payroll provider for a copy of the plan document and the date it was adopted. If they can't produce one, adopt one before your next plan year.

## Limits and exceptions

- **Owners can't participate the same way.** Sole proprietors, partners and more-than-2% S corporation shareholders aren't treated as employees for Section 125.
- **High earners.** Above the Social Security wage base ($184,500 in 2026), only the 1.45% Medicare portion is saved on the extra dollars.
- **Individual policies.** Employees generally can't pay individual-market premiums pre-tax through a POP. ICHRA allowances, which are already tax-free, are the usual route. Employees who pay more than their allowance may be able to pay the difference pre-tax for off-exchange plans.
- **Mid-year changes.** Elections can change only after a qualifying event, such as marriage or a birth.

> **Pre-tax isn't free money for everyone:** Lower taxable wages slightly reduce Social Security benefits and can lower the wage base for some disability or life insurance formulas. The tax saving is almost always larger, but it's worth knowing.

## What else a cafeteria plan can cover

A premium only plan is the simplest form of Section 125 plan. Once you have the plan document, adding other pre-tax benefits is straightforward, and each one adds payroll tax savings on both sides.

**Benefits that can run through a Section 125 plan**

| Benefit | What employees can pay pre-tax | 2026 limit |
| --- | --- | --- |
| Premium only plan (POP) | Their share of medical, dental and vision premiums | None |
| Health FSA | Deductibles, copays and other medical costs | $3,400 per employee |
| Dependent care FSA | Child care and other dependent care | $7,500 per household |
| HSA (with an HDHP) | Contributions to their HSA | $4,400 self-only / $8,750 family |

The dependent care limit rose from $5,000 to $7,500 for 2026 under the One Big Beautiful Bill Act, the first increase in decades. Health FSAs and HSAs don't mix: a general-purpose health FSA makes someone ineligible for HSA contributions, though a limited-purpose FSA for dental and vision is allowed.

**Adding a dependent care FSA for five parents**

Illustrative. Five employees each set aside the full $7,500 for child care, in the 22% bracket with 5% state income tax.

- Total set aside: $37,500
- Employer payroll tax saved (7.65%): $2,868.75
- Each parent saves (34.65%): $2,598.75

The company saves almost $2,900 a year and each parent about $2,600, on top of premium savings, from the same plan document.

Cafeteria plans must pass nondiscrimination tests, and "key employees" can't receive more than 25% of the plan's total tax benefits. Small companies where owners and executives put away a lot through a dependent care FSA occasionally fail this test, so ask your administrator to run it each year.

## Lowering the premium itself

A Section 125 plan trims taxes on premiums. The bigger lever is the premium. Both of our products work with your existing payroll provider, so pre-tax deductions keep running the way they do today.

> **Prescience Diamond: A company health plan with an effective $0 deductible.** Employee contributions to a Prescience Diamond plan run pre-tax through Section 125 like any group plan.
> - **An effective $0 deductible** and simple copays shown before a visit
> - **A broad national PPO network,** plus providers we contract with directly
> - **24/7 physician-led care navigation** that books visits and explains costs
> - **Usually 10–20% below comparable fully insured coverage,** fixed in your quote, with no admin fees
> Best for teams of about 15 or more that want one great group plan. [Get a Diamond quote](https://www.getprescience.com/get-started?p=Employer&product=diamond)

> **Prescience Choice: ICHRA for $20 per enrolled employee per month.** Choice allowances are tax-free to employees by design, so there's no premium deduction to set up for the allowance itself.
> - **You set a monthly allowance;** each employee picks and owns an individual plan
> - **$20 per enrolled employee per month,** with no setup or platform fee
> - **Works in all 50 states and DC,** so remote and multi-state teams fit
> - **Plan comparison, enrollment help and Crystal,** our assistant for benefits questions
> Best for small teams, teams in several states, and anyone pricing ICHRA. [Get a Choice quote](https://www.getprescience.com/employer/choice)

## Frequently asked questions

**How much does a Section 125 plan save an employer?**

7.65% of every dollar employees contribute toward premiums, for pay below the Social Security wage base. On $100,000 of employee contributions that's $7,650 a year.

**How much does a Section 125 plan save employees?**

Their Social Security and Medicare rate (7.65%) plus their federal income tax bracket and, in most states, state income tax. That's often 25% to 35% of what they contribute.

**Do I need a plan document for a premium only plan?**

Yes. Section 125 requires a written plan adopted before the plan year begins. Without it, the deductions are taxable.

**Can business owners pay premiums pre-tax through Section 125?**

Not sole proprietors, partners or more-than-2% S corporation shareholders. Their health insurance is handled through other tax rules.

**Does a Section 125 plan work with ICHRA?**

ICHRA allowances are already tax-free. If employees pay more than the allowance for an off-exchange individual plan, the employer can let them pay the difference pre-tax through a cafeteria plan.

**Is a POP the same as an FSA?**

No. Both are Section 125 benefits, but a POP only covers premiums. A health FSA lets employees set aside pre-tax money for out-of-pocket medical costs.

## Sources

- [IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits](https://www.irs.gov/publications/p15b)
- [IRS, FAQs for government entities regarding cafeteria plans](https://www.irs.gov/government-entities/federal-state-local-governments/faqs-for-government-entities-regarding-cafeteria-plans)
- [IRS, Topic 751, Social Security and Medicare withholding rates](https://www.irs.gov/taxtopics/tc751)
- [Social Security Administration, Contribution and benefit base](https://www.ssa.gov/oact/cola/cbb.html)
- [KFF, 2025 Employer Health Benefits Survey](https://www.kff.org/health-costs/2025-employer-health-benefits-survey/)