United States

Office of

Personnel Management

The Federal Government’s Human Resources Agency

Retirement and Insurance Service

Benefits Administration Letter

 

Number: 00-204 Date: February 11, 2000 

Subject: Federal Employees Health Benefits (FEHB) Program: Premium Conversion

This letter provides advance information about new rules the Office of Personnel Management

(OPM) will soon issue to permit employees of all Executive branch agencies to pay their share of

enrollment costs under the FEHB Program with pre-tax dollars, and thus increase their after-tax

income. 

The President has directed OPM to promptly issue guidance and take all necessary action to

ensure smooth implementation across the Executive branch. Similar plans are already available to

the majority of employees of private sector employers and State and local governments, as well as

employees of the United States Postal Service, the Federal Judiciary, and several small Federal

agencies.

Section 125 of the Internal Revenue Code allows an employer to provide a portion of an

employee’s salary in benefits rather than cash. Instead of paying a certain amount to an employee

as taxable income, the employer uses it to purchase benefits for the employee. A health insurance

premium conversion plan reduces an employee’s taxable income by the amount of health

insurance premiums an employee would otherwise have to pay. This enables the employee to

save on Federal income tax, Social Security and Medicare tax and, if applicable, State and local

income taxes. 

Under the Internal Revenue Code, premium conversion plans are only available to current

employees and only affect the portion of insurance premium that employees normally pay. 

Federal agencies will continue to be responsible for the Government share of premiums as

provided in the FEHB law. The tax code imposes certain limitations on reducing health plan

coverage during a calendar year and premium conversion may also slightly reduce the base for

Social Security benefits. Accordingly, participation in premium conversion will be automatic

unless employees waive it. 

_________________________________________________________________________________________ 

Civil Service Federal Employees Federal Employees Federal Employees

Retirement Group Life Health Benefits Retirement

System Insurance Program System
2

We expect that the implementation of premium conversion can be completed not later than

October 1, 2000. OPM will amend its rules and will prepare instructions for agency personnel

and payroll offices, materials for employees, and procedures for employees who want to waive

participation. The attachment to this letter provides additional information.

Attachment

Abby L. Block, Chief

Insurance Policy

 and Information Division
_______________________________________________

United States Office of Personnel Management Page 1

PRESIDENT EXTENDS HEALTH INSURANCE PREMIUM CONVERSION TO

ALL EXECUTIVE BRANCH EMPLOYEES

February 7, 2000

The President’s Action Achieves Two Objectives.

Equal treatment for Federal employees. Right now, the majority of private

sector employees and State and local government employees are able to take

advantage of a tax code provision that increases their after-tax income.

Employees of the United States Postal Service, the Federal Judiciary and a

number of smaller Federal agencies already have this tax advantage, while the

majority of Federal employees are now excluded. The President’s action will

allow all employees of Executive Branch agencies to enjoy the same tax benefit.

Improving the Government’s ability to recruit and retain staff. Because most

Federal agencies have been unable to provide their employees with the same tax

benefit as other employers in the labor market, the President’s action will improve

the Government’s competitive position as an employer.

Guidance to Federal Employees and Agencies. The President has directed the Office

of Personnel Management to issue guidance promptly to ensure smooth implementation

of premium conversion across the Executive Branch. At this time, we expect

implementation can be completed by all agencies no later than October 1, 2000.

The Office of Personnel Management Will Continue to Pursue Improvements. The

Office of Personnel Management is working on a series of initiatives to improve Federal

compensation and benefits. For example, as announced in the President’s Fiscal Year

2001 Budget, the Administration is seeking ways to strengthen the Federal Employees

Health Benefits Program, including enhanced dental benefits and other improvements in

the program.

Today, President Clinton announced that Federal employees throughout

the Executive Branch of the Government will for the first time be able to

take advantage of tax benefits that most employees in the country

already enjoy. As a result, most employees participating in the Federal

Employees Health Benefits Program will see an increase in their takehome pay and the Federal Government will become more competitive as

an employer.
_______________________________________________

United States Office of Personnel Management Page 2

HEALTH INSURANCE PREMIUM CONVERSION

QUESTIONS AND ANSWERS

Q. What is premium conversion and how does it work?

A. Premium conversion reduces an employee’s taxable income by the amount of his

or her insurance premium. As a result, the employee pays less tax.

Section 125 of the Internal Reve nue Code allows an employer to provide a

portion of an employee’s salary in benefits rather than cash. Instead of being paid

to the employee as taxable income, this amount is used to purchase benefits for

the employee. The effect is that the employee’s taxable income is reduced.

Under a health insurance premium conversion arrangement, an employee’s

taxable income is reduced by the amount of health insurance premiums withheld

from pay. Because taxable income is reduced, the amount of tax the employee

must pay is reduced. The employee saves on Federal income tax, Social Security

and Medicare tax and, if applicable, State and local income taxes.

Q. How are health insurance premiums taxed now?

A. An employee receives salary and then has a withholding from salary to pay the

premiums for health insurance. The employee must pay tax on the salary

received, that is, the amount received before the health insurance premium is

withheld. The employee pays tax on a larger amount of income than he or she

receives as take-home pay.

Q. How much does an employee save with premium conversion?

A. To determine the amount saved, an employee must determine his or her highest

combined tax rate and the total amount of health insurance premiums. If, for

example, an employee’s combined rate for Federal and local income taxes, Social

Security tax and Medicare tax is 35%, and if the employee’s annual health

insurance premiums total $1,400, the employee’s annual reduction in taxes would

be $490 (1,400 x .35 = 490).

Q. When will premi um conversion begin?

A. The Office of Personnel Management expects that the implementation of

premium conversion can be completed not later than October 1, 2000.

Q. Will there be an open season to sign up for premium conversion?

A. No. Participation in premium conversion will be automatic. Employees will have

no forms to fill out, unless they waive participation.
_______________________________________________

United States Office of Personnel Management Page 3

Q. Why would an employee waive premium conversion?

A. In the vast majority of cases, employees will want to participate in premium

conversion. In a limited number of circumstances, however, it may be to an

employee’s advantage to waive it. The Internal Revenue Code imposes certain

annual limitations that may affect some employees who expect to change plans

during a calendar year. Also, because premium conversion reduces the amount of

taxable income, it may also slightly reduce the base on which Social Security

benefits are calculated. The Office of Personnel Management’s guidance will

include a full explanation that will help employees decide whether to participate

in premium conversion.

Q. What about employees who already have premium conversion?

A. Employees of the United States Postal Service, the Federal Judiciary, the

Comptroller of the Currency, the Federal Deposit Insurance Corporation, the

Office of Thrift Supervision, and the Federal Reserve System already have health

insurance premium conversion. They are not affected by the President’s action to

extend premium conversion to other agencies.

Q. Will the Government still pay the same share of my premium?

A. Yes. The Government will still pay the same share of premiums as provided in

the Federal Employees Health Benefits Act. The premium conversion plan only

affects the portion of premiums now paid by employees.

Q. Is this a permanent benefit?

A. Yes, but each year employees may decide whether they want to participate for the

following year.

Q. Is the plan “Family Friendly?”

A. Absolutely. The plan will make health premiums more affordable and will

increase employees’ take-home pay.

Q. Is this benefit comparable to what the private sector offers to its employees?

A. Yes, most large private sector employers, as well as most State and local

governments, offer their employees premium conversion plans.

Q. Will this put me in a different grade or step?

A. No. Participating in the premium conversion plan will not affect your grade and

step. It will only reduce the amount of tax you pay.
_______________________________________________

United States Office of Personnel Management Page 4

Q. Was there a change in tax policy that permitted this recent development?

A. No. Section 125 of the Internal Revenue Code already permitted employers to

offer premium conversion plans.

Q. Will this pre-tax benefit also apply to retirees, survivors, and former spouses who

are receiving civil service benefits?

A. No. Under section 125 of the Internal Revenue Code, the tax advantages of a

premium conversion plan are only available to current employees.

Q. Can I purchase health benefits outside of the Federal Employees Health Benefits

Program with pre-tax dollars?

A. No, the tax advantage only applies to premiums for the Federal Employees Health

Benefits Program.

Q. Will a premium conversion plan help the Federal Government better manage its

human resources?

A. The plan will enhance the Federal Governm ent’s ability to compete with the

private sector in recruiting and retaining qualified employees. Agencies have

expressed a strong desire for pre-tax benefits as recruitment and retention tools.

Q. How many Federal employees will now be able to benefi t from the tax advantages

of a premium conversion plan?

A. Approximately 1.6 million Federal employees will now be able to enjoy the tax

advantages already enjoyed by almost 1 million employees of the Postal Service

and other smaller Federal agencies.

Q. What is a flexible spending account?

A. A flexible spending account (FSA) is an arrangement under which an employee

elects to have his or her employer place a portion of salary into an account that

can be used to reimburse the employee for medical or dependent-care costs.

Subject to restrictions in the Internal Revenue Code and Internal Revenue Service

regulations, the amounts placed in the account are not subject to taxation at the

time they are placed there or at the time they are disbursed from the account.

The agencies mentioned above that now offer health insurance premium

conversion also offer FSAs, which are commonly available to private-sector

employees and State and local government employees. The Office of Personnel

Management is considering the feasibility of extending FSAs and other modern

benefit options to all employees in the Executive Branch.

***