The tax efficiency of benefits should be a key consideration in how you structure employee plans
By: Bill Zolis
The basic math behind the concept of tax efficient benefits is a bit of a no-brainer. Let’s say that you have decided that it’s time to put more money into the overall remuneration budget. You want to make the job more attractive to retain or recruit staff, but you also want to get the biggest bang for your buck.
If you do the obvious thing and just give everyone a pay raise equal to their share of the extra money, then right away you find that each extra $100 you put into the pot could be costing you $105 or $110 because you have to pay increased Employer Health Tax, Canada Pension Plan contributions, Employment Insurance premiums and perhaps even Workers’ Compensation assessments. All of those things are based on your overall payroll.
Next, the employees who end up with that extra $100 on their paycheques are going to get hit even harder. They have to pay tax and all the other deductions on their increase. And, of course, the extra tax kicks in at their top rate, which hurts even more if the increase bumps them into a higher bracket. So the employee might see only $75 or $70 or even less of that extra $100. Which, don’t forget, actually cost you as much as $110.
Not very tax efficient. Or very cost effective.
Now, on the other hand, if you put the increased remuneration funds into tax-free benefits, it all adds up very differently. Let’s say you put an extra $100 into health or dental. It’s not payroll, so there is no bump in things like the health tax. And the employee pays no tax on the benefit.
So that extra $100 you put into tax-free benefits buys you $100 or more – much more, I’d say – of employee satisfaction.
In survey after survey that we have reported on in the past, employees tell us that a good benefits plan is right at the top of their wish list, and that health, dental, and prescription coverage are seen as the most important or desirable.
Or look at what, in my opinion, is an under-utilized opportunity in the range of allowable tax-free benefits: the health care spending account. Look at the math. If you have an employee making $60,000 per year, and you give that person a 1% raise, it will cost you perhaps $650, net the employee less than $20 per paycheque after deductions — and not greatly impress anybody.
However, if you give that person a $500 health care spending account, the employee does not pay tax on it and has the full benefit available to use. Even if the employee maxes out the spending account and after you pay admin fees, everyone is still ahead of the game. You will be well under the $650 that a 1% raise in salary would have cost you and, more important, the employee is going to be delighted.
In other words, a 1% bump in total remuneration will be appreciated much more by employees if it comes in the form of a highly-visible benefit than if it comes in the form of a very small increase in salary.
Plan sponsors and benefits professionals are pretty familiar with what sorts of benefits are taxable and which ones are not. Plan members, on the other hand, often have no idea of what’s taxable, what’s not taxable, and what it means to them. I think that, in a lot of cases, plan members see a deduction on their pay statement for certain benefits, and perhaps some reference to tax paid on taxable benefits, and just assume that a “better” benefits plan would cover those costs for them.
No so, of course. That’s why I think it’s very important for employers to explain the tax status of their benefits to employees.
Basically, employers pay the costs for most benefits, but employees usually pay the premiums for disability coverage. That, we should point out to our plan members, is because of the way the tax rules are structured. If the employer paid the premium for LTD, any benefits paid out should the employee make a claim would be taxable.
In other words, we can say, “We’d love to pay those premiums, but we wouldn’t be doing you any favours if we did.”
Another option for some plan sponsors would be to propose a group retirement plan as an alternative to cash bonuses or raises in pay. Again, the employees would be far better off than if they took the increase in the form of taxable pay.
The bottom line here is that I think we should look at overall remuneration with salary and benefits all on the table at the same time. And, again, biggest bang for the buck: how can we give employees the most possible total remuneration within our total budget? And how can we generate the highest level of employee satisfaction within that budget?
First, let’s look at those tax-free benefits that employees tell us they value the most: health, dental, prescription. Then let’s get creative with things like health care spending accounts and group retirement plans.
Second, let’s look at those taxable benefits that are most valued by employees, that have high visibility, and that have “generous benefits plan” written all over them.
Third, let’s make sure we educate our plan members about their benefits plans.
To me, trying to stretch your overall remuneration budget and trying to build the well workplace without factoring in both the tax efficiency and the employee satisfaction associated with benefits is just like leaving money on the table.
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I really appreciate comments, ideas, suggestions or just observations about the blog or any other topics in benefits management. I always look forward to hearing from readers. If there’s anything you want to share, please email me at bill@penmorebenefits.com.
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