While employers typically pay most of their employees' health care costs, rising premiums may have you looking for ways to cut costs. A tax-free savings account for health care might be the answer.
By W. Eric Martin
Health care coverage is a perk that every employee craves, but employers are finding it increasingly difficult to bear the cost of covering their workers. From 1998 to 2003, the cost of annual individual premiums jumped 42 percent to nearly $3,500, according to the Robert Wood Johnson Foundation.
On average, businesses shoulder four-fifths of that cost, yet even with that much assistance available, fewer employees are signing up for employer-provided health insurance due to rising premiums.
If you’re worried about the long-term health of your business, and are considering canceling health care coverage altogether, you should consider a new type of tax-free savings account that can give you—and your employees—a way to stay healthy without ending up in the poorhouse.
The ABCs of HSAs
In 2003, changes to Medicare created the Health Savings Account (HSA), a tax-free money shelter that works like a 401(k). Employees and employers can deposit funds into an HSA, but instead of that money being put aside for retirement, it can be used to pay health care costs for that worker and his or her family.
As you might expect, the inner workings of an HSA are more complicated than they seem at first glance, but the U.S. Department of the Treasury’s Web site spells out all the details.
First, anyone who wants an HSA must be covered by a High Deductible Health Plan (HDHP) and have no other type of health insurance. The amount of your deductible—the amount of money an employee must pay toward an insurance claim—under the HDHP determines how much you can deposit into an HSA, up to a limit of $2,700 for individuals and $5,450 for families in 2006. (These amounts will rise annually to account for inflation.)
As with your contributions to 401(k) plans, you can reduce your taxable income by the amount that you deposit in an HSA, but if you spend these funds for anything other than “qualified medical expenses,” then you must pay taxes plus a 10 percent penalty on what you withdraw. A partial list of acceptable medical expenses can be found in IRS Pub 502; the list includes a wide variety of medical services, such as dental and vision care, acupuncture, psychoanalysis, chiropractic care, and other treatment often excluded from traditional insurance.
Funds in an HSA are managed by a bank, credit union, or other financial institution and you pay medical bills by using a checkbook or credit card for that account. Whatever HSA funds you don’t spend in a calendar year are rolled over and available for use in later years, earning interest while they wait. If you drop the HDHP, you can no longer contribute to the HSA, but you can still spend any funds already in the account for medical expenses.
HSAs funds can be used tax-free after retirement for medical expenses or you can count that money as income and use it for other purposes. If you’re over 55, you can make additional “catch up” contributions of up to $1,000 annually.
What HSAs Mean For Employers
Switching from a traditional co-pay insurance plan to an HDHP plan for your employees will lower your health care costs by about one-third, according to JoAnn Laing, president of Information Strategies Inc., a marketing and media firm in Fort Lee, N.J., that studies the HSA marketplace and runs HSAfinder.com.
The problem with making such a switch is that your employees must pay a higher deductible, which can run into the thousands, before the insurance starts to cover costs—and this is where HSAs come in.
In essence, HSAs move health care decisions from the employer to the employee. “Conceptually, HSAs are part of a movement called ‘consumer directed health care,’” says Lou Garafalo, managing director, employee benefits practice, at The Bostonian Group, a business consulting firm in Boston.
Most people are not educated consumers of health care services because they don’t directly foot the bills, says Garafalo. With an HDHP that forces employees to pay at least the first $1,000 of their health care expenses—using their HSA, if they have one—they will become more responsible in their choice of physicians and services, choosing generic drugs over brand names, for example, or living healthier lifestyles to avoid the need for medical care.
HSAs are the carrot to match the HDHP’s stick. In addition to paying for an employee’s HDHP, you can donate funds to his or her HSA and let that employee decide whether or not to spend those funds because, as with 401(k) plans, HSAs are owned by the employee, not the employer.
The amount you donate naturally will determine the amount you save on health care expenses; after all, if switching from an HMO to an HDHP saves you, say, $80 per employee per month, donating that $80 to an HSA account will keep your expenses exactly the same—although you will save on insurance in the long run. “This year the cost of high deductible plans is expected to increase by 2 percent, while the cost increase for HMO and PPO plans is about 7 percent,” Laing says.
Instead of forcing employees to switch, you might consider adding the HDHP/HSA combo to your list of insurance possibilities and educating employees about the long-term benefits of this plan. “Employers view this as a way to show employees that they’re thinking of the [employees’] future,” says Chad DiBonaventura, small business solutions consultant with The Bostonian Group. “Money in an HSA is going to be there when they retire to pay medical expenses.”
Employees also save money in the short term because each individual’s share of the insurance premium drops by one-third and contributions to the HSA are tax-deductible. What’s more, Laing says, “73 percent of people spend less than $500 per year in medical expenses.” For employees who find themselves in that stat, HSAs could be an easy sell.
While rising insurance premiums have sent employers in a tizzy, offering your employees some form of health coverage is better than going without, as it will give you a competitive advantage and allow you to attract—and retain—better employees. “Forty percent of small and medium-sized businesses don’t offer health care,” Laing says, “but they find that when they do, morale and profitability go up.” HSAs now give you another option, one that will save both you and your employees money in the long run.