Premium Only Plan (POP)

A written Section 125 plan document that lets employees pay their share of group health premiums with pre-tax dollars. Having the document is just the start; every Section 125 plan must also pass three annual nondiscrimination tests.

See the Step-by-Step ProcessView Templates & Tools

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What A written plan document establishing a Section 125 cafeteria plan that allows employees to pay group health insurance premiums on a pre-tax basis (salary reduction). Must include annual nondiscrimination testing to verify the tax benefit isn't skewed toward owners and executives.
Who Any employer that deducts employee health insurance premiums from payroll on a pre-tax basis. If pre-tax deductions are happening without a signed, written plan document, the employer is out of compliance, even if deductions have been running for years.
When The plan document must be in place before the first pre-tax payroll deduction. Nondiscrimination testing should be completed annually, ideally mid-year so you have time to correct problems before the plan year ends.
Risk Employers without a plan document lose the pre-tax deduction for all employees, meaning back payroll taxes could be owed. If nondiscrimination tests fail, only highly compensated individuals (HCIs) or key employees lose the tax exclusion; rank-and-file employees are unaffected. There is no specific statutory dollar penalty for a missing POP document, but failure to maintain a written plan document disqualifies the entire Section 125 arrangement retroactively.
Before
First deduction

The plan document must be adopted before the first pre-tax payroll deduction. No retroactive adoption.

Annual
Nondiscrimination testing

Run the three Section 125 tests each year, ideally mid-year, to allow time for corrections.

3-5 yr
Restatement

Amend for any material change; best practice is to restate the full document every 3 to 5 years.

Event Timing Notes
Initial plan document adoption Before the first pre-tax payroll deduction Retroactive adoption is not permitted. Date the document before the effective date.
Annual open enrollment Before the start of each plan year Employees must make their salary reduction elections before the plan year begins. Elections are irrevocable except for permitted mid-year change events.
Nondiscrimination testing Annually; ideally mid-year No IRS filing required, this is an internal test. Run it early enough to make corrections before year-end if a test is failing.
Plan document restatement Whenever there is a material plan change Adding an FSA, changing the plan year, or changing eligibility rules each require a formal amendment. Best practice: restate the full document every 3 to 5 years.
New hire elections Within the window specified in the plan document (typically 30 days of eligibility) If no election is made, the new hire defaults to after-tax premiums for the remainder of the plan year.
Event: Initial plan document adoption
Timing: Before the first pre-tax payroll deduction
Notes: Retroactive adoption is not permitted. Date the document before the effective date.
Event: Annual open enrollment
Timing: Before the start of each plan year
Notes: Elections made before the plan year and irrevocable except for permitted change events.
Event: Nondiscrimination testing
Timing: Annually; ideally mid-year
Notes: Internal test, no IRS filing. Run early enough to correct before year-end.
Event: Plan document restatement
Timing: On any material plan change
Notes: Adding an FSA, changing the plan year, or eligibility rules requires a formal amendment.
Event: New hire elections
Timing: Typically within 30 days of eligibility
Notes: No election means the new hire defaults to after-tax premiums for the year.
  • Employer information: Legal name, EIN, principal address, and the name or title of the plan administrator (typically the employer or HR director).
  • Plan year dates: The 12-month period the plan covers; most employers use a calendar year (January 1 to December 31), but this must match the benefit plan's renewal date.
  • Insurance plan details: The names of the group health, dental, and vision plans offered, and the employee-share premium amounts at each coverage level.
  • Employee census (for NDT): A list of all employees showing name, hire date, job title, annual compensation, ownership percentage (if any), and whether they are enrolled in the plan.
  • Prior-year W-2 compensation: Required to identify highly compensated individuals; the HCI threshold for 2026 testing is $160,000 in 2025 compensation.
  • Ownership information: Any employee who owns 5% or more of the business is an HCI regardless of compensation. Any employee who owns 1% or more and earns over $150,000 is a key employee.
  • Signed election forms: Completed pre-tax election authorization for each participating employee, signed before the plan year (or within the new-hire election window).
  • Plan document template: See the Templates & Resources section below.

Part A: Setting Up or Updating the Plan Document

1
Download the POP plan document templateUse the template in the Templates & Resources section below. The IRS does not publish a model Section 125 plan document; the requirement under IRC Section 125(d) is simply that a written document exist specifying the plan year, eligible employees, available benefits, and election procedures.
2
Complete all fill-in fieldsAt minimum: employer name, EIN, plan year dates, eligibility conditions and waiting period, a list of qualifying premiums covered by the plan, and the name of the plan administrator. Blue fields in the template indicate required customization. If you want to enroll employees automatically on an opt-out basis, also add the negative-election provision, see the optional language in Templates & Resources below.
3
Have it reviewedFor most small employers with a straightforward POP, the plan document is low-risk. That said, if you have multiple owners, complex benefit structures, or are uncertain about any provision, a brief review by an ERISA attorney is worthwhile.
4
Sign and date the documentAn authorized officer of the employer must sign and date the document before the first pre-tax deduction is taken. The execution date must be on or before the effective date.
5
File itKeep the original in your benefits files. No IRS filing is required. Provide a copy to any employee who requests it (ERISA requires this).
6
Update as neededAny material change, adding an FSA, changing the plan year, changing eligibility rules, requires a formal written amendment signed before the change takes effect.

Part B: Annual Nondiscrimination Testing

The Section 125 rules require three annual tests. Use the NDT Calculator in the Templates & Resources section to walk through each one.

1
Identify your HCIs and key employeesHCIs for 2026 testing include: (a) all officers regardless of compensation; (b) any employee who owns 5% or more of the business; and (c) any employee who earned more than $160,000 in 2025 (the prior plan year). Key employees for 2026 include: (a) officers earning more than $235,000; (b) 5%+ owners; and (c) 1%+ owners earning more than $150,000.
2
Run the Eligibility TestAt least 70% of non-excludable employees must benefit from the plan (Test A), or at least 80% of eligible non-excludable employees must benefit if 70% or more of non-excludable employees are eligible (Test B). Either safe harbor passes the test.
3
Run the Benefits & Rights TestEvery benefit available to HCIs must also be available to non-HCIs on the same terms. For a POP with one benefit (pre-tax premium reduction), this test is usually a straightforward pass, as long as the same arrangement is available to everyone.
4
Run the Key Employee Concentration TestTotal benefits (pre-tax premium dollars) flowing to key employees must not exceed 25% of all benefits flowing to all participants. Add up the annual salary reductions for key employees and divide by the total salary reductions for all participants.
5
Document the resultsKeep a written record of your test calculations each year: who was classified as HCI/key employee, the employee counts or dollar amounts used, and whether each test passed. This documentation protects you if the IRS asks.
6
Take corrective action if a test failsIf a test is failing mid-year, options include reducing HCI/key employee contribution amounts, broadening eligibility to include more non-HCIs, or restructuring the benefit offering. Year-end corrections are limited; act early.

When Is Testing a Formality vs. When Does It Actually Matter?

For many small employers, all three tests pass automatically and the "testing" is really just confirming what you already know. Testing is most likely a formality when:

  • Most or all eligible employees participate in the plan (high participation means an easy Eligibility Test)
  • Everyone gets the same benefit on the same terms (Benefits & Rights Test passes by default)
  • The company has few or no owners/officers, or owner/officer premiums are a small fraction of total premiums (Key Employee Concentration Test passes easily)

Testing requires more attention when:

  • The employer is closely held (few employees, most of whom are owners or family members)
  • A large percentage of total premiums flows to owners, officers, or high earners
  • Different employee classes get different benefit options or contribution levels
  • Participation among rank-and-file employees is low (many eligible employees opt out)
  • Summary Plan Description (SPD): ERISA requires employers to provide a Summary Plan Description to each participant. For most POP arrangements, the plan document doubles as the SPD. Provide a copy to each newly eligible employee when they become eligible to participate.
  • Employee election forms: Each participant must make a written (or electronic) salary reduction election before the plan year begins (or within the new-hire election window). Keep the signed election on file; no election, no pre-tax deduction.
  • Document requests: ERISA requires you to provide a copy of the plan document to any participant who requests one in writing, within 30 days, for a reasonable copying fee.
  • Mid-year changes: If an employee experiences a permitted change-in-status event, the election change must be documented in writing and processed prospectively, not retroactively. Keep the documentation in the employee's file.
  • Electronic delivery: Election forms and the SPD may be delivered electronically if the employer meets the DOL's electronic disclosure safe harbor requirements (employees must have regular access to the system and opportunity to opt out of electronic delivery).
  • Signed plan documentThe original signed and dated plan document (and any amendments). Retain indefinitely; this is foundational.
  • Annual election formsSigned salary reduction election for each participant, for each plan year. Retain for at least 6 years (consistent with ERISA recordkeeping requirements).
  • Mid-year change documentationWritten record of each mid-year election change, including the qualifying event, date of event, and new election. Keep with the employee's personnel file.
  • Nondiscrimination test resultsA written record of each year's NDT calculation: employee census used, HCI/key employee classifications, test inputs, and pass/fail results. Retain for at least 6 years.
  • Payroll records showing pre-tax deductionsYour payroll system should reflect the salary reduction amounts by employee. These are your supporting data for the NDT and for demonstrating the plan was operated consistently with the written document.
  • SPD distribution recordsA log or confirmation showing when the SPD was provided to each participant (at plan inception and when new employees become eligible).

Common traps

No written plan document: Many employers take pre-tax deductions for years without a signed plan document. This is the single most common POP violation. Without the written document, the Section 125 arrangement is not valid and all pre-tax deductions are technically incorrect. Get the document signed before the next payroll cycle.
Backdating the plan document: The IRS does not permit retroactive adoption of a Section 125 plan. If you adopt it mid-year, it is only effective going forward; you cannot fix prior payrolls by backdating the document.
Skipping the NDT because "we're small": There is no size exemption from nondiscrimination testing (unless you qualify for the Simple Cafeteria Plan safe harbor under IRC Section 125(j), see Special Cases). Even a 3-person company must pass the tests.
Allowing mid-year changes without a qualifying event: A participant who changes their mind partway through the year cannot simply change their election. Changes are permitted only when a specific IRS-recognized event occurs (marriage, divorce, birth, change in employment status, etc.).
Confusing the POP with the health plan: The POP is a salary reduction arrangement; it has nothing to do with which health plans are offered or what they cover. It just lets employees pay their share of the premium pre-tax. The POP is silent on benefits; the insurance carrier's plan documents govern what is covered.

FAQs

Does the plan document need to be filed with the IRS?

No. There is no IRS filing requirement for a Section 125 POP. The plan document is an internal employer document. You are required to retain it and make it available to participants on request, but you do not submit it to the IRS or DOL as a standalone document. (The plan may be referenced in a Form 5500 filing if one is required.)

What happens if the employer never had a plan document but has been taking pre-tax deductions?

Technically, every pre-tax deduction taken without a valid written plan document was improper. In practice, the IRS rarely audits this proactively, but if discovered during an audit, it can result in back payroll taxes and penalties for the employer. The practical fix is to adopt a plan document immediately, going forward, and ensure all future deductions are compliant.

What's the difference between an HCI and a key employee?

Both terms describe categories of employees who receive special treatment under the nondiscrimination tests, but they are used in different tests. HCI (highly compensated individual) is the category used in the Eligibility Test and Benefits & Rights Test; it includes all officers (regardless of compensation), 5%+ shareholders, and employees earning over $160,000 in the prior year (2025, for 2026 testing). Key employee is used only in the Key Employee Concentration Test; it includes officers earning over $235,000, 5%+ owners, and 1%+ owners earning over $150,000 (2026 figures). Some employees may qualify as both; most rank-and-file employees are neither.

If the nondiscrimination tests fail, do all employees lose the pre-tax benefit?

No. If any of the three tests fail, only the affected HCIs or key employees lose the tax exclusion for that year; their excess benefits are included in their gross income and taxed accordingly. Rank-and-file (non-HCI, non-key) employees are completely unaffected and keep their pre-tax benefit regardless of the test outcome.

Can the employer contribute to the POP on behalf of employees?

A POP is funded entirely by employee salary reductions; the employer is not required to contribute. If an employer wants to contribute, that is handled through the insurance plan's billing structure, not through the Section 125 plan document. Note that employer contributions reduce the amount of "benefits" counted for NDT purposes, which can help smaller employers pass the Key Employee Concentration Test.

Can we enroll employees in the POP automatically, on an opt-out basis?

Yes, if your plan document authorizes a negative (automatic) election, you give employees advance notice of the default, and you give them a real chance to opt out before it takes effect. The IRS has permitted this for Section 125 plans since Rev. Rul. 98-30. The requirements and a ready-to-use notice and opt-out form are on the Salary Reduction Agreement page.

  • Simple Cafeteria Plan (IRC Section 125(j)), Safe Harbor for Small Employers: If your company had 100 or fewer employees on business days during either of the two preceding plan years, you may elect Simple Cafeteria Plan status. A qualifying Simple Cafeteria Plan automatically satisfies all three nondiscrimination tests, no calculations needed. To qualify, you must: (a) make eligibility available to all employees with at least 1,000 hours in the prior year; (b) make the same contribution available to all eligible employees (either a minimum of 2% of compensation, or the lesser of 6% of compensation or 200% of the lowest-paid participant's salary reduction); and (c) not restrict eligibility based on compensation or ownership. If you qualify, this safe harbor is worth strongly considering.
  • S-corporation owners: A 2% or greater S-corporation shareholder is treated as a partner, not an employee, for Section 125 purposes. These individuals may not participate in the Section 125 plan; their premiums must be paid outside the plan. A 2% shareholder who takes a pre-tax deduction through the POP is receiving an improper tax benefit.
  • Partners and sole proprietors: Partners in a partnership and sole proprietors are not employees under the tax code and cannot participate in a Section 125 cafeteria plan. If the business has a mix of partners and employees, only the employees may participate.
  • Self-employed individuals and more-than-2% S-corp owners: These individuals may deduct health insurance premiums under IRC Section 162(l), which provides a self-employed health insurance deduction. This deduction is available above-the-line but does not affect FICA taxes. It is a different rule from Section 125.
  • HSA compatibility: A Health Savings Account (HSA) is compatible with a POP only if the employer adds an HSA contribution option via a formal plan amendment. You cannot simply allow employees to make HSA contributions through a POP without the amendment. The amendment is straightforward, but it must be done before the contributions begin.
  • State income tax: Pre-tax premium deductions under a Section 125 plan reduce federal income tax and FICA taxes in all states. However, a few states (notably New Jersey and Pennsylvania) do not conform to Section 125 for state income tax purposes, meaning the pre-tax premium may still be taxable for state purposes even though it is federal tax-exempt. Check your state's rules.
  • Government employers: State and local government employers (entities described in IRC Section 115) may not maintain a Section 125 cafeteria plan. Federal government employers are also excluded. This is a federal tax code limitation, not a regulatory choice.

Two tools to help you do this yourself: a customizable POP plan document template and an interactive calculator for the annual nondiscrimination tests.

POP Plan Document Template (Word)

A complete Section 125 Premium Only Plan document template, formatted for US Letter and ready to customize. Open the file, fill in the blue fields (employer name, EIN, plan year, eligibility conditions, etc.), sign it, and you have a compliant written plan document. Includes all required sections: eligibility, elections, mid-year change events, irrevocability rule, nondiscrimination testing disclosure, COBRA, ERISA participant rights, and Appendix A with key definitions.

⬇ Download POP Plan Document Template (.docx)

Optional: Negative-Election (Auto-Enrollment) Plan Provision

If you want to enroll employees in the pre-tax premium election automatically, on an opt-out basis, rather than collecting a signed election from each one, your plan document must expressly authorize it (Rev. Rul. 98-30). Add a provision like the following to your POP plan document, then use the employee notice and opt-out form on the Salary Reduction Agreement page to communicate the default and collect opt-outs.

Automatic (Negative) Election. For any Plan Year, the Employer may provide that an eligible Employee who does not make an affirmative election during the enrollment period will be deemed to have elected to pay his or her share of the premiums for the coverage(s) designated by the Employer on a pre-tax basis through salary reduction (the "default election"), in the amount(s) determined by the Employer and stated in the automatic-enrollment notice. Before the default election takes effect, the Employer will give the Employee a written notice describing the default election, the amount of the salary reduction, the Employee's right to elect instead to receive cash or to pay the premiums on an after-tax basis, and the procedure and deadline for making that alternative election. A newly eligible Employee will be given a reasonable opportunity to make an alternative election before the first compensation from which the salary reduction would be withheld becomes currently available; a current Employee will be given that opportunity before the beginning of the Plan Year. An Employee who does not make an alternative election by the stated deadline will be bound by the default election, which will be irrevocable for the Plan Year except as otherwise permitted under the mid-year election change provisions of this Plan.

Have your TPA or ERISA counsel confirm this language fits your plan document and adopt it before the first automatic deduction is taken.

Section 125 Nondiscrimination Testing Calculator

A downloadable Excel workbook that walks you through all three required Section 125 nondiscrimination tests. Enter your employee roster in the Census tab, one row per employee with compensation, ownership percentage, officer status, and enrollment data, and the Test Results tab calculates where you stand on the Eligibility Test, Benefits & Rights Test, and Key Employee Concentration Test. Formulas are visible so you can see exactly how each result is derived. Save a completed copy each year as part of your plan records.

⬇ Download Section 125 NDT Worksheet (.xlsx)

These tools are for educational purposes and do not constitute legal or tax advice. Consult a qualified ERISA attorney or CPA before finalizing your plan document or relying on test results for tax reporting purposes.