I recently read a document recommending that employers pay 100% of group insurance premiums. The author suggested that employers would find it financially profitable to reduce employee salaries and pay the full amount of premiums, instead of keeping salaries at their current level and share premium costs with employees, on a 50-50 basis for example.
Is this really the case? Does this approach truly generate lasting savings? Are there any tax-related risks involved? Here are some answers!
Source of the concept
The idea of reducing salaries in exchange for the full payment of group insurance premiums, also known as standardization, goes back to the 1990s when it was promoted by many advisors. The concept is simple. When employees pay their share of group insurance premiums, they do so with after-tax dollars: all payroll taxes along with provincial and federal income tax deductions have already been applied to the salaries before insurance premiums are withdrawn. Theoretically, employer-paid premiums in exchange for a reduced salary would lead to lower income tax and payroll taxes, thus reducing the total cost of insurance coverage.
Changing tax environment in Quebec
However, over the years, taxation has changed markedly in Quebec. Premiums paid by employers for health care, dental care, and life, accidental death and critical illness insurance plans are now deemed a taxable benefit at the provincial level (in Quebec only). Moreover, this taxable benefit is subject to contributions to the Quebec Pension Plan, Health Services Fund, Labour Standards Commission and Workforce Skills Development and Recognition Fund.
At the provincial level, the Quebec Parental Insurance Plan contribution is the only payroll tax for which these premiums are not considered as a taxable benefit!
What about federal taxation?
For the time being, the life, accidental death and critical illness insurance premium is the only employer-paid premium considered as a taxable benefit at the federal level. Premiums paid for other benefits are not subject to federal income tax or EI contributions.
Potential savings in group insurance premiums
Despite the current rules, it is still possible to generate some savings, particularly if disability insurance premiums represent a substantial portion of insurance costs. Potential savings will therefore vary considerably from one employer to the next and from one member to the next, based on selected coverage (individual, family or exempt) and on salaries. For a typical group, we estimated that savings for the first year represent approximately 20% of total group insurance premiums.
Is this legitimate?
But a fundamental question remains: Is it legitimate for employers to reduce their employees’ salary instead of making them pay their share of premiums with after-tax money, in order to avoid paying personal federal income tax and EI contributions on these premiums? The answer will depend on the situation of each employer, on a case-by-case basis.
If a new contract is signed with employees and provides for a reduced salary and the employer’s commitment to pay the insurance premiums, the arrangement will probably be accepted by CRA.
However, if the employer continues to administer the former salaries and document them in the annual review letters, and systematically recalculates the salary normalization every year based on premium increases, it could be quite difficult to allege that a new contract has been entered into… and the salary reduction could be deemed spurious; should the employer be audited, the amount by which the salary was reduced could be subject to federal income tax and EI contributions.
Ultimately, is this a good solution?
Given the current taxation environment, proceeding with an annual salary standardization under which the employer would cover the total cost of the group insurance plan appears to us as a time-consuming and needlessly risky exercise.
A one-time standardization exercise that would redefine the employment contract and provide for the full payment of insurance premiums by the employer could generate savings, but it comes with its share of challenges:
- The employer could be faced with future premium increases that exceed salaries as health care benefits have historically been subject to fairly high annual inflation rates. Based on our calculations, the savings could give way to additional costs in less than 5 years time.
- Equity between employees could be questioned, since the standardized salary of a member with individual coverage will be reduced to a lesser extent than the salary of an employee with family coverage. Thus, two employees holding the same position would end up having different salary levels.
- The standardization exercise will result in reduced coverage for employees, as the amount of salary-based benefits, such as life insurance and short- and long-term disability insurance, will necessarily be based on the reduced salary.
Although standardization may be a good idea, it offers little advantage to employers given the current legal and fiscal context.
Did you implement salary standardization in your business in recent years? If you want advice on how to best unwind it, do not hesitate to contact an AGA Benefit Solutions advisor!
Martin Papillon is a Fellow of the Canadian Institute of Actuaries and holds an MBA from HEC Montréal. Throughout his career, he has been working in the group insurance and retirement sector. Before joining AGA in 2013, he held advisory and senior management positions with world-class consulting actuarial firms.
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