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Small Business Employee Benefits and HR Blog

How to Get Tax-Free Individual Health Insurance

Historically, most Americans purchase health insurance from their employers because employer-sponsored health insurance costs (and distributions) can usually be excluded from employees’ income for purposes of calculating income and payroll taxes. This results in significant tax savings and benefits for many employees and employers. But, what if you have individual health insurance? 

The History of Tax-Free Group Health Insurancetax free individual health insurance

The concept of tax free health insurance began in the U.S. in the 1940s. During World War II, the government ruled that company-provided fringe benefits (e.g. health insurance) could be excluded from wartime wage controls. Unable to increase wages due to the wartime controls, many companies decided to increase health insurance benefits as a way to compete for top employees.

Group Health Insurance vs Individual Health Insurance

Individual health insurance plans are health insurance plans purchased by individuals to cover themselves or their families. Anyone can apply for individual health insurance. 

Group health insurance plans are a form of employer-sponsored health coverage. Costs are typically shared between the employer and the employee, and coverage may also be extended to dependents. 

The Growth of Individual Health Insurance

The number of people buying individual health policies is growing rapidly. Once a person obtains an individual health policy, they can renew it until age 65 regardless of employment and their premium cannot be increased solely due to their own large claim (e.g. $1 million). Premiums do increase each year with general medical inflation, but cannot be increased due to individual claims history.

And, in 2014:

  1. Most individuals and families will receive a massive subsidy from the federal government to buy individual health insurance through an exchange, and

  2. Insurance companies will no longer be able to decline individuals for individual health insurance based on a pre-existing medical condition. 

As a result, many small businesses are expected to terminate group health insurance (in favor of individual health insurance) in 2014.

How to Get Tax-Free Individual Health Insurance

If you are self-employed

If you have self-employment income, then you can take a deduction for health insurance expenses incurred for yourself, your spouse, and your dependents. You can claim the health insurance deduction as an "above the line" tax deduction on Form 1040.

If you are a W-2 employee

If you are a W-2 employee, ask your employer to set up an HRA (or Health Reimbursement Arrangement). The HRA can reimburse you for your individual health insurance premium (and that reimbursement can be excluded from your taxable income).

What is an HRA?

HRA plans are employer-funded medical reimbursement plans. The employer sets aside a specific amount of pre-tax dollars for employees to reimburse health care expenses (including health insurance premiums). HRA reimbursements are 100% tax deductible to the employer, and tax-free to the employee.

The Comprehensive Guide to the Small Business HRA