What Federal Employees Need to Know About FEHB Premium Conversion

Federal employees shelter their share of the FEHB plan premium from income taxes through what is called "Premium Conversion." Employees have the right to opt out of this program. This increases very slightly future Social Security benefits. However, in what economists call "present value" terms, that offsetting amount is a very small fraction–a few pennies on the dollar–of the gains from the Premium Conversion program. We strongly advise all employees NOT to opt out of Premium Conversion tax savings.

How much employees gain from this tax subsidy varies depending on employee salary, spousal salary, other income, state income tax rate, number of dependents, amount of deductions, whether they file jointly, and whether they are in FERS (and hence paying Social Security taxes). The overall marginal tax rate can often reach 40 percent, or even more in some high tax states.

At income ranges typical of Federal employees, whether in single- or dual-earner families, and whether in the FERS or CSRS retirement systems, almost everyone will save at least 25 percent, and very few will save much more than 40 percent, from tax-sheltered health care premiums or other expenses.

Because the effects of different marginal tax rates are relatively small in comparing plans, and never change our relative rankings or the general magnitude of plan-to-plan differences, we use a 33 percent premium savings estimate in all Guide tables for employees, who are eligible for Premium Conversion. This simplifies presentation and gives you the essential information you need to compare plans. You can, of course, make your own calculation of marginal tax rate, but this is complicated and will not affect most plan comparisons substantially.