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HEALTH CARE PLANS FOR EMPLOYEES

 PLAN 1 – PREMIUM ONLY CAFETERIA BENEFIT PLAN (POP)

This is often the best choice for small employers. With this type of plan, your employees pay their share of premium costs via paycheck withholding. Employees pay their share of premiums with pretax dollars. The tax savings can be quite substantial, even for lower-paid workers.

Without a POP, most employees receive no tax relief for their share of premium costs, because medical expenses are deductible only in excess of 7.5% of a taxpayer’s adjusted gross income (AGI). With a POP, tax savings offset the cost of being saddled with a bigger chunk of the health coverage bill.

A POP saves taxes on your side of the deal too because the salary reductions used to pay your worker’s portion of health insurance premiums are also exempt from the employer’s share of Social Security and Medicare taxes. For 2003, these taxes cost your company 7.65% of the first $87,000 of each employee’s salary, plus 2.9% of any compensation above that level.

Here’s the catch: A POP is the simplest “cafeteria benefit plan,” which means it falls under tax code section 125. So you’ll need a written plan document and employee enrollment procedures to reap the tax advantages. Also, the POP can’t discriminate in favor of your highly compensated employees. And a POP can’t deliver more than 25% of its nontaxable benefits (salary reduction amounts used to pay employees’ share of premiums) to your key employees.

PLAN 2 – FLEXIBLE SPENDING ACCOUNT (FSA) PLAN

This is the second simplest strategy. It probably works best for companies employing at least 50 workers. Your company sets up a health care flexible spending account (FSA) plan. Your workers then make annual elections  to contribute a specified salary amount to their personal FSAs. Contributions are withheld from employee paychecks. Employees then use their FSA money to reimburse themselves for their share of health insurance premiums plus uninsured medical expenses (deductibles, co-payments and expenses not covered by insurance, such as dental and vision-care costs).

Money contributed to employee FSAs are salary reductions, which means it is exempt from income tax, plus Social Security and Medicare taxes. In essence, this arrangement lets your employees pay their out-of-pocket medical expenses (including their share of health insurance premiums) with pretax dollars.

The FSA strategy allows your company to shift more health benefit costs to the employees while providing them with offsetting tax savings. The only loser is the IRS. The FSA arrangement saves taxes on your company’s side, as well, because salary reduction amounts used to fund employee FSAs are exempt from the employer’s share of Social Security and Medicare taxes.

Now for the catches: Like POPs, FSA arrangements fall under Section 125 cafeteria-benefit plan tax guidelines explained earlier. Also, the “use-it-or-lose-it” FSA provision means employees forfeit any amounts left in their accounts at year-end. Forfeitures can actually be good news for your company, because they must be returned to the employer’s coffers under IRS rules.

FSA plans require significant administrative work to enroll employees, handle payroll withholding and process FSA reimbursement claims. That’s why your best option is to hire a third party administrator to handle these functions.

PLAN 3 – MEDICAL SAVINGS ACCOUNT (MSA) PLAN

This strategy is available to smaller employers only. However,  it’s also complicated. With a Medical Savings Account (MSA) plan, your company provides employees with coverage under a high-deductible medical insurance policy. In other words, you pay only for catastrophic health coverage, which should be much cheaper than a traditional policy. (You can also require employees to pay part of the catastrophic policy premiums if you wish).

Personal MSAs are set up for each employee. You decide who puts the money in that account. It can be either the company or the employee, but not both if you want the tax advantages.

What’s the tax benefit? The company deducts contributions it makes and the pay-ins represent a tax-favored fringe benefit for employees (meaning free of income tax and Social Security and Medicare taxes). If employees make MSA contributions with their own money, their annual pay-ins are deductible above the line (meaning they need not itemize to benefit).

Once their MSAs have been funded, employees can invest the account balances. Earnings grow tax-free. Employees can take tax-free withdrawals to reimburse themselves for out-of-pocket medical expenses. But they can’t use MSA withdrawals to pay their share (if any) of premiums for the qualified high-deductible health insurance policy.

MSAs have no use-it-or-lose-it rule, so the money remains year to year. MSA plans also encourage employees to avoid unnecessary medical expenses, since that’s the only way to preserve their MSA balances. Note that your employees’ MSA balances are fully vested and portable. So when a worker quits, the MSA money goes with the worker.

Who’s eligible? MSAs are available only to small employers, meaning 50 or fewer workers during either of the prior two years. If a growing small company sets up an MSA plan, it can continue enrolling new hires in the plan until the year after it reaches 200 employees. From then on, existing employees can stay in the plan, but new hires can’t set up MSAs.

The maximum annual contribution to each employee’s MSA depends on the annual catastrophic policy’s deductible. For 2003, annual policy deductibles for single coverage can range between $1,700 and $2,500. Deductibles for family coverage can range between $3,350 and $5,50 (IRS Revenue Procedure 2002-70).

For employees with single coverage, the maximum MSA contribution is 65% of the annual policy deductible. For employees with family coverage, the maximum contribution is 75% of the policy deductible.

PLAN 4 – HEALTH REIMBURSEMENT ARRANGEMENTS (HRAs)

This is best suited to larger employees. With a health reimbursement arrangement (HRA), your company contributes a fixed annual amount to each eligible employee’s health care reimbursement account. Employees are not allowed to contribute their own money to HRA accounts. The company deducts its HRA contributions, and the pay-ins count as a tax-favored fringe benefit for your employees, meaning free of income tax and Social Security and Medicare taxes. (HRAs are sometimes called consumer-driven health plans.)

Employees then submit proof of their uninsured medical expenses and receive tax-free HRA account reimbursements. So your workers are able to pay their out-of-pocket medical expenses with pre-tax dollars.

Since your company makes all the HRA contributions, this concept makes sense only when offered in conjunction with a plan offering low-cost catastrophic coverage. The idea is that your company will reap massive health insurance cost savings, which in turn will permit fairly generous contributions to employee HRA accounts, with the company still coming out well ahead.

HRA accounts are not subject to the use-it-or-lose-it rule, so employees can carry over their HRA balances. This gives them a strong incentive to avoid unnecessary medical expenses. Unlike MSA plans, HRA programs are available to both large and small employees, and they place no annual limit on contributions to each employee’s HRA account. (IRS NOTICE 2002-45). For these reasons, some employers may view the HRA deal as a more flexible strategy for shifting health care costs to employees, while providing them with a valuable tax break as part of the bargain.

The following articles are for informational purposes only, and your should always consult with your tax advisor to determine the tax implications for your particular financial situation.

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