The Cheapest Form of a Raise

In this blog post, we examine the financial impact of offering employees a 5% raise versus offering employer-provided group health insurance. We’ll breakdown the true costs and benefits and determine which proposition is most financially sound. Keep in mind, this post is heavy on the details. If you prefer a high-level overview, we can certainly accommodate that.

Let’s start with a 5% raise. I think most people would be very happy with a 5% raise. However, looks can be deceiving. For the sake of discussion, let’s assume our employee’s annual gross salary is $50,000. A 5% raise would yield a salary increase of $2,500. This increases the employee’s annual gross ‘taxable’ salary to $52,500. Once taxes are taken out, the difference in take home pay (net income) between $50,000 and $52,500 is approx. $1,700. Thanks to Uncle Sam, the true value of the $2,500 raise is closer to $1,700. The more money you make, the more you pay in taxes (proportionately speaking). 

So what’s the cost to the employer to pay for a $2,500 raise? For starters, you would include the gross cost of the raise which is $2,500. The less obvious inclusion would be the additional taxes the employer has to pay as a result of the employee’s gross salary increasing by $2,500. Those additional payroll taxes are approx. $200. When you combine the gross cost of the raise and the additional tax liability for the employer, you’re left with a total cost of $2,700. In the case of a 5% raise, the out-of-pocket cost exceeds the value of the benefit. Would you spend $2,700 on something that only has a value of $1,700?

Now let’s turn our attention to the cost of offering employer provided health insurance. Instead of using the $2,700 on a 5% raise that has a true value of only $1,700, the employer can instead use that money as a contribution towards employee premiums. That contribution comes out to $225/month. If the employee contributes an additional $175/month (done on a pre-tax basis), you now have $400/month going towards the cost of health insurance.  

If you total up the employee’s monthly contributions, you have a yearly contribution of $2,100. Remember, that money is pre-tax (i.e. it reduces the employee’s taxable income). The employee’s taxable income is now $47,900 as oppose to $52,500 with the 5% raise. A lower taxable income means less payroll taxes for the employer. In this case, the employer realizes a savings in payroll taxes of approx. $400. If you subtract the $400 savings from the $2,700 the employer is contributing towards medical coverage, you come up with a benefit that has more value than the actual cost to provide that benefit.

If that’s not a good enough reason to investigate the possibility of implementing an employee benefits solution, the employer contribution of $2,700 is also tax deductible. If you apply this single scenario to a business with 10 employees, you’re looking at $27,000 per year that can be written off. This makes sense and it’s great for the bottom line.  

Aside from the quantitative measures, there’s also a qualitative component. Employees appreciate benefits. Often times they don’t realize the true value of their benefits, but they understand the importance. Benefits can be used to retain and attract good talent. This is especially true in industries where businesses are competing for scarce talent. A good benefits package shows that you care about the well-being of your employees. Research shows that employees with good benefits are generally healthier and less likely to miss work. They’re also happier and more productive while they’re at work.

We encourage you to investigate the possibility of establishing your own employee benefits package. Our professionals will help you tailor a solution that fits your budget and also provides excellent coverage for your employees. Once you decide on a plan, we can even show you how it compares to other companies in your industry. Our benchmarking tool allows us to compare your plan to 31,000 employers and 50,000 plans nationwide.