The Short Answer: Yes, With Four Rules Attached
Paying cash to an employee who waives the group medical plan — called cash in lieu, an opt-out payment or a waiver credit — is still allowed in 2026. No federal rule bans it. What changed under the ACA is how the payment is counted, and a design that looked like a simple retention perk ten years ago can quietly make a plan unaffordable today.
Four rules decide whether an opt-out program is a sensible cost lever or a liability: how the payment is taxed, how it affects ACA affordability, who it may not be offered to, and how it touches overtime.
Rule One: Run It Through a Section 125 Plan
When employees can choose between cash and a tax-free benefit, the IRS constructive receipt doctrine says the choice itself can make the benefit taxable — for everyone, including the employees who take the coverage. The fix is to offer the choice inside a Section 125 cafeteria plan. The plan document is what lets the employees who enroll keep paying their share of premium pre-tax.
The opt-out payment itself is ordinary wages: subject to income tax withholding, FICA and FUTA, and reported on the W-2. If your cafeteria plan document does not name the opt-out payment as a cash option, it needs to before the first payment goes out.
Rule Two: Affordability Depends on Whether the Cash Has Strings Attached
For employers with 50 or more full-time equivalent employees, the employer mandate tests whether the cheapest self-only plan that meets minimum value costs the employee no more than a set share of income: 9.96% for plan years beginning in 2026 and 10.22% for 2027 (see the ACA affordability percentage for 2026 and 2027). An opt-out payment can raise the employee’s cost for that test. Whether it does depends entirely on how the offer is designed.
| Arrangement | What the Employee Must Do to Get the Cash | Effect on Affordability |
|---|---|---|
| Unconditional opt-out | Decline the medical plan. Nothing else. | The payment is added to the employee’s contribution. Enrolling means giving up the cash, so the IRS treats the forgone cash as part of the price of coverage. |
| Eligible (conditional) opt-out | Decline, and provide reasonable evidence — an annual attestation is enough — that the employee and everyone in their tax family have other coverage that is not individual-market coverage. | Not added to the employee’s contribution. |
A worked example shows why this matters. The cheapest self-only option costs the employee $250 a month, and the employer pays $150 a month to anyone who waives, no questions asked. For the affordability test the employee’s cost is $400 a month, or $4,800 a year. Under the W-2 safe harbor at 9.96%, that plan is affordable only for employees earning about $48,200 or more. Without the opt-out payment it would have been affordable down to about $30,100. Everyone in between just became an employee with an unaffordable offer — and if one of them buys Marketplace coverage with a premium tax credit, that is what triggers an employer mandate penalty.
The eligible opt-out rules come from proposed IRS regulations issued in 2016 that have never been finalized. Until final rules arrive, payments under an eligible opt-out arrangement are not counted toward the employee’s contribution. An unconditional payment also flows into the employee required contribution reported on Form 1095-C, which is where the problem usually surfaces first.
Rule Three: Medicare-Entitled Employees Cannot Be Offered It
Under the Medicare Secondary Payer rules, an employer with 20 or more employees may not offer a financial incentive for a Medicare-entitled employee or spouse to turn down the group health plan. Penalties apply per violation.
The design that stays on the right side is an offer made on identical terms to every eligible employee, never one aimed at people who are on or approaching Medicare. If Medicare-entitled employees are a meaningful share of your group, have ERISA counsel review the program before it launches — we can bring counsel in through the firm.
Rule Four: Health Status and Overtime
HIPAA nondiscrimination rules bar tying the offer to health. Making the payment available only to employees with high claims, or steering it toward someone in the middle of treatment, is prohibited.
For non-exempt employees, cash paid in lieu of benefits generally belongs in the regular rate used to calculate overtime. A federal appeals court held exactly that in 2016, and including the payment is the conservative approach for any hourly workforce.
Should You Offer It at All?
The case for it is arithmetic. Every employee who waives a family plan saves the employer its whole contribution for that tier, and a modest opt-out payment is usually a fraction of that. For a spouse who already has good coverage elsewhere, cash is worth more than a duplicate plan.
The case against it is participation. Small-group carriers set minimum participation requirements, and a waiver usually only escapes that count when the employee has other group coverage. An unconditional payment invites waivers from people with no other coverage, which can push a small group below the carrier’s floor. In a self-funded or level-funded plan it also tends to pull out the healthiest enrollees first, which raises the cost per person who stays.
So if we recommend an opt-out at all, it is almost always the conditional version. Requiring proof of other group coverage solves the affordability problem and the participation problem at the same time. Set the amount by comparing it with what your contribution for the waived tier actually costs, not by carrying forward last year’s number. If your current plan design has never been checked against these rules, send us your renewal and we will look at it with the rest of the plan.
Questions We Get
Is cash in lieu of health insurance still legal?
Yes. Employers can still pay employees who waive the group medical plan. The payment should be offered through a Section 125 cafeteria plan, and for employers with 50 or more full-time equivalent employees its design affects the ACA affordability test.
Is an opt-out payment taxable to the employee?
Yes. Cash in lieu of benefits is ordinary wages, subject to income tax withholding, FICA and FUTA, and reported on the W-2. Offering it through a cafeteria plan is what keeps the choice from making the health coverage taxable for the employees who enroll.
Does an opt-out payment affect ACA affordability?
Only if it is unconditional. A payment made to anyone who waives is added to the employee’s contribution for the affordability test. A payment made only to employees who show that they and their tax family have other coverage, not individual-market coverage, is not added.
What counts as proof of other coverage?
Under the proposed IRS rules, a written attestation from the employee is enough, collected at least every plan year, confirming that the employee and everyone in their tax family have or will have minimum essential coverage other than individual-market coverage. The employer cannot rely on it if it knows the coverage does not exist.
Can we offer opt-out cash only to some employees?
Classes based on the job, such as full-time and part-time, are generally workable, subject to the cafeteria plan’s own nondiscrimination tests. Classes based on health status or Medicare entitlement are not.
We have fewer than 50 employees. Do these rules still apply?
The affordability penalty does not apply below 50 full-time equivalents, but the cafeteria plan rules, HIPAA and overtime rules do, and the Medicare rule applies from 20 employees. At your size the carrier’s participation minimum is usually the rule that bites first.
Does cash in lieu of benefits count toward overtime pay?
Generally yes, for non-exempt employees. A federal appeals court held in 2016 that these payments belong in the regular rate of pay, and including them is the conservative approach.
General information about opt-out payments, not legal or tax advice. Plan-specific questions belong with ERISA counsel, and we will bring them in.
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