Section 125 Health Insurance: How Employers Set It Up

Reviewed by a licensed benefits professional. Last reviewed: October 2, 2026.

Section 125 health insurance is a tax setup that sits on top of the group health plan you already offer. It does not change your carrier, your network or your benefits. It changes how the premium dollars are taxed, and for most employers that is a free raise for the team and a lower payroll tax bill for the company.

Key facts

• Employer-provided accident and health benefits are exempt from income tax withholding, Social Security tax and Medicare tax (IRS Publication 15-B, 2026).
• Employers pay Social Security tax of 6.2% on wages up to $184,500 and Medicare tax of 1.45% with no cap, which totals 7.65% on most wages (Social Security Administration, 2026).
• Workers paid an average of $1,440 a year toward single coverage and $6,850 toward family coverage in 2025 (KFF Employer Health Benefits Survey, 2025).
• 59% of firms with 10 to 199 workers offered health benefits in 2025 (KFF Employer Health Benefits Survey, 2025).
• A cafeteria plan must be a written plan, and a 2% shareholder of an S corporation is not treated as an employee for it (IRS Publication 15-B, 2026).
• Summit Health Benefits charges a $35 per enrolled employee per month admin fee, paid out of the FICA savings the plan creates (Summit Health Benefits, 2026).

What is Section 125 health insurance?

Section 125 health insurance is group health coverage whose employee premiums are paid through a Section 125 cafeteria plan, so the money comes out of pay before tax. The insurance itself comes from your carrier. Section 125 is the tax wrapper around it.

IRS Publication 15-B (2026) describes a cafeteria plan as a written plan that lets employees choose between cash and certain qualified benefits. When an employee picks a qualified benefit such as health coverage, the fact that cash was an option does not make the benefit taxable.

Many employers hear "Section 125 plan" and think it is a new kind of insurance. It is not. Our Section 125 cafeteria plan guide covers the full rules, and the short version is this: same coverage, different tax treatment.

How does a Section 125 plan work with group health insurance?

A Section 125 plan works by letting employees elect a premium deduction from each paycheck before income and payroll taxes are figured. Their taxable wages shrink by the premium amount, and so does the employer's payroll tax.

Here is the flow in four steps:

1. The employer signs a written plan document that names the benefits offered, such as medical, dental or vision.
2. Each employee elects how much of the premium to pay through the plan, before the plan year starts.
3. Payroll deducts the premium pre-tax each pay period. Box 1, Box 3 and Box 5 wages on the W-2 end up lower by that amount.
4. The employer pays the carrier as usual. Nothing changes for the carrier.

Employees cannot change elections whenever they like. Under 26 CFR 1.125-4, a plan is not required to allow mid-year changes, and plans that do allow them limit them to events such as marriage, divorce, a birth, or a change in employment status. Our guide to how to set up a Section 125 plan walks through the paperwork.

How much does Section 125 save on health insurance premiums?

Section 125 saves the employee income tax and 7.65% FICA on every premium dollar, and it saves the employer 7.65% FICA on the same dollars. The numbers below are hypothetical and use 2026 FICA rates.

One employee paying $400 a month for health premiums, after tax vs through Section 125 (hypothetical, 12% federal bracket)

Now scale it. Take a 10-person business where every employee pays $400 a month toward premiums.

1. Pre-tax premiums per month: 10 x $400 = $4,000.
2. Employer FICA avoided per month: $4,000 x 7.65% = $306.
3. Employer FICA avoided per year: $306 x 12 = $3,672.
4. Employee tax saved per person per year: $943.20, or about $78.60 a month.

The employee side is the part staff notice, because take-home pay goes up while the coverage stays the same.

Summit Health Benefits' admin fee is $35 per enrolled employee per month, which is $4,200 a year for 10 employees (Summit Health Benefits, 2026). Premium dollars alone produce $3,672 in employer FICA savings in this example, and the $35 divided by 7.65% works out to about $457 of pre-tax contributions per employee per month to cover the fee from premiums alone. That is why a Summit advisor also counts other qualified benefits, such as dental, vision and an FSA, when sizing a plan. Summit lists the net employer benefit at $56 to $101 per enrolled employee per month after the fee (Summit Health Benefits, 2026). Run your own headcount in the Section 125 calculator.

For the full payroll tax math, read our guide to maximizing FICA tax savings.

Who can participate in a Section 125 health plan?

Employees can participate in a Section 125 health plan, along with their spouses and dependents if the plan covers them. Owners who are not treated as employees cannot, which catches some small businesses off guard.

IRS Publication 15-B (2026) says not to treat a 2% shareholder of an S corporation as an employee for this purpose. A single-owner S corporation therefore cannot run its owner's premiums through the plan. Our guide to Section 125 for S corporation shareholders explains what owners can do instead.

Is a Section 125 plan the same as a premium only plan?

A premium only plan is the simplest kind of Section 125 plan, and it covers only the employee's share of health premiums. A full cafeteria plan can add a health FSA, dependent care and other qualified benefits.

IRS Publication 15-B (2026) sets the 2026 health FSA salary reduction limit at $3,400. If you only want to pre-tax premiums, a premium only plan is enough. If you want your team to also pay for out-of-pocket costs with pre-tax dollars, add an FSA. Read premium only plans for small business for a side-by-side.

Does Section 125 replace group health insurance?

No. Section 125 does not replace group health insurance, and it does not pay medical claims. It only changes how employees pay their share of the premium.

If you do not offer group coverage yet, you need a carrier first. KFF's 2025 survey found 59% of firms with 10 to 199 workers offer coverage, so you are competing with most of your hiring market. Get quotes first, then add Section 125 to the plan you choose.

How is Section 125 different from an ICHRA?

Section 125 changes the tax treatment of premiums employees already pay, while an ICHRA is an employer-funded reimbursement for individual coverage. They solve different problems, and they are not interchangeable.

Section 125 works with a group plan. An ICHRA works with individual policies. Our guide to how an ICHRA works shows when the second option fits better.

What should I ask my broker about Section 125 health insurance?

Ask your broker whether Section 125 is already in place, who holds the plan document, and who runs payroll set-up. Many employers pay for group health with after-tax premium deductions for years because nobody asked.

Copy this email and send it as written:

Subject: Is our group health plan running through a Section 125 plan?

>

Hi, I am reviewing our group health benefits for next plan year. Please confirm: (1) whether employee premiums are deducted pre-tax under a written Section 125 plan, (2) who holds the plan document and when it was last updated, (3) what we pay for administration, if anything, and (4) what the FICA savings would be for our current headcount. Thank you.

If the answer to the first question is no, you are paying FICA on dollars that could be exempt. Read how brokers handle Section 125 before you reply to a quote.

Frequently Asked Questions

Sources: IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits (2026); Social Security Administration, Contribution and Benefit Base and tax rates (2026); 26 CFR 1.125-4, Permitted election changes (2026); KFF, 2025 Employer Health Benefits Survey (2025); Summit Health Benefits, Section 125 plan pricing and fee structure (2026).