Business Insurance Underwriters - Tax Friendly Plans

Tax Friendly Plans

Making "Tax Favorable" Accounts Easy

The rising cost of insuring the world’s premier health care system has led to the popularity of Consumer Driven Healthcare Plans. Although not the silver bullet touted by politicians and the media, CDHP have allowed many employers to regain control of their benefits expenses.

These plans use a combination of high deductible insurance policies and one or more tax favorable accounts. Many of these accounts have been around for years but were only used by large employers. The increase of CDHP’s and the number of plan administrators allows the small employer and their employees to take advantage of these programs.

We can help you take advantage of these programs by designing a new benefit package or amending your current one. Contact us to discuss the possibilities.

Health Flexible Spending Accounts: They began in the 1970’s as a way to allow employees to pay for health care items with tax free funds. Their popularity was limited by the “use it or lose it” feature that was over emphasized for many years. It referred to the fact that any unused funds remaining in the account at the end of the calendar year were lost to the employee. Those funds actually revert back to the employer.

To overcome this negative view, the IRS and Congress have expanded the rules affecting FSA’s. First the IRS ruled that over the counter drugs are an eligible item for FSA funds. This allows an employee to spend any unused funds at the end of the year on such things as cold and allergy medicines, aspirin, Advil, Tylenol and band aids. Congress also allowed, with employer approval, the extension of the plan year by 10 weeks. With these improvements there should be no reason that the employee fails to use his funds.

FSA’s can also be funded by the employer. One tactic to reduce benefit cost is to pay employees if they waive the employers health insurance in favor of their spouse’s plan. According to IRS letter rulings, the only way to do that and avoid negative tax consequences is to place the funds in an FSA for the waiving employee.

Health Reimbursement Accounts: These accounts can only be funded by the employer. They give the employer an enormous amount of flexibility in the design and administration of a health benefits program. An account can be established and fully funded for each employee. Unused amounts, at the employer discretion, can roll over annually and later be used as a supplement to the employees retirement income.

We seldom recommend a plan design that generous. To begin with the combination of a fully funded account and the premiums of even a high deductible insurance policy will exceed the cost of a fully insured policy. If your goal is to reduce cost while maintaining comprehensive coverage, fully funded accounts miss the mark.

A more realistic design is to only fund the account when and if claims arise. In this way, only eligible items are paid for and there are no funds to roll over at the end of the year. With normal claims usage, an employer can experience real savings with this type of HRA. The added plus is that in many cases employee benefits can actually be increased.

Health Savings Accounts: The newest and most hyped of all the accounts, HSA’s are not for everyone. These plans lack the flexibility in design of a HRA. They can be funded by both the employee and the employer. Funds, however, must be placed in the account without regard to actual claims. Those funds belong to the employee even when they leave employment. Similar to the fully funded HRA, there is rarely a savings experienced in overall cost.

HSA’s can be offered to employees as a second or third option in a benefits package. Funding the account can be left at the employees discretion. In some cases, employers have elected to make an initial one time deposit in the HSA as a transition from a traditional policy.

IRS Code 213(d): This is where the IRS spells out what medical expenses it allows to be paid for tax free with funds from one or more of the above accounts. The employer is NEVER responsible if funds are used for ineligible items. That is between the employee and the IRS.

COMPARING ACCOUNTS
Plan Design or Compliance Issues	Health FSA's	HRA's	HSA's
Internal Revenue Code
Who Qualifies?	Workers whose employers provide it	Workers whose employers provide it.	All taxpayers under age 65 covered by a qualified high deductible health plan.
Purpose	Worker and/or employer funded accounts used to pay our of pocket medical and dental costs.	Employer funded program to reimburse workers for out of pocket costs of a high deductible plan. May cover part or all of the plan’s deductible.	Promote use of high deductible insurance plans by sheltering income used to pay health care costs.
Tax Benefits	Worker forfeits unspent money at the end of each year. No interest paid on account balances.	Plan costs are tax deductions for employer. Reimbursement to worker is not treated as income. Unused funds can rollover at the end of the year. Employer may keep the money when a worker quits or retires.	Tax free contributions and withdrawals when used for health expenses. Non-health withdrawals after age 65 are taxed but not penalized. Annual contribution limits: Maximum of $2,900 to meet an individual health plan’s deductible: $5,800 for family plan.
Salary reduction funding	Permitted	Not permitted for HRA, but permitted for HDHC.	Permitted for both HSA and HDHP. Also, the HSA may be funded with deductible (after tax) employee contributions
Carryover of unused amounts	Not permitted	Permitted	Permitted
Medical expenses that are eligible for reimbursement	Otherwise unreimbursed Code 213(d) medical expenses incurred during the coverage period. Cannot reimburse insurance premiums. Cannot reimburse qualified long term care services.	Otherwise unreimbursed Code 213(d) medical expenses incurred while coverage in effect, including premiums for eligible health insurance and long-term care insurance. Cannot reimburse qualified long-term care services so long as the HRA is an FSA.	Otherwise unreimbursed Code 213(d) medical expenses incurred while coverage in effect, but not for expenses for insurance other than premiums for COBRA, qualified long-term care contract, or for a health plan while the individual is receiving: 1. unemployment compensation, or 2. is over age 65 (other than a Medicare supplement policy).
Cash-outs of unused amounts	Not permitted.	Not permitted.	Permitted, but such amounts are taxable. Cash out of unused amounts are subject to a 10% excise tax. Excise tax does not apply for individuals disabled, who die or are over the age of 65. Tax-free transfers after divorce or death of the account beneficiary are permitted.
12 month period of coverage & Prohibition of mid-year changes.	Applies	Does not apply.	Applies to HDHP if funded through cafeteria plan. Unclear if applies to HSA when HSA is funded with pre-tax salary reduction. N/A to HSA if it is funded by employer or after-tax employee (I.e. individual contribution) basis.
Health FSA uniform coverage requirement	Applies - i.e., maximum amount of coverage must be available throughout coverage period (generally 12 months)	Does not apply - (i.e., coverage level may be prorated by plan design).	Does not apply
Ability to spend down unused amounts after termination of active participation	Cannot use unused amounts to pay for claims incurred after termination: but COBRA rights may apply	HRA can permit unused amounts to be used until depleted to pay for claims incurred after termination; and COBRA rights will apply too.	Unused amounts can be distributed post-termination, subject to income and excise tax for non-qualified medical expenses.
Claims must be incurred during current period of coverage	Applies	To a certain Extent, does not apply - (I.e., claims incurred but not reimbursed in an earlier period while the individual was a participant can be reimbursed in subsequent year if individual is still a participant).	Does not apply; however, expense must be incurred after HSA is established.
Expense substantiation	Required	Required	It is the individual account holder who is responsible for determining if expenses are for a qualifying medical expense, not the HSA trustee or custodian and not the employer.
Claims Adjudication	Required	Required	Not Required
Code 105(h) nondiscrimination requirement	Applies	Applies	Does not apply, but if employer makes contributions new Code 4980G requires that comparable contributions (equal dollar amount or equal percentage of deductible) be available for similarly situated participating employees. Pre-tax salary reductions, which are considered employer contributions for IRS purposes, will vary by participatng; however, Conference Report indicates this should not result in discrimination. Employer matching contributions based on salary reductions could be a problem. Unclear to what extent Section 125 discrimination rules may apply.
Is a trust account required?	No, not by the IRC, but possibly by ERISA (no trust if health FSA complies with ERISA Tech. Rel 92-01, including that reimbursements are made directly out of the general assets of the employer).	No, not by the Code, but possibly by ERISA (no trust if HRA reimbursements are made directly out of the general assets of the employer).	Yes
Are account earnings taxable?	Not applicable if reimbursements are made directly out of the general assets of the employer. If funded with a VEBA, earnings are generally not taxable.	Not applicable if reimbursements are made directly out of the general assets of the employer. If funded with a VEBA, earnings are generallly not taxable.	No, not if there is a qualified HSA trust (see rules regarding cash out amounts)
ERISA (for ERISA-covered employers)			It is not clear to what extent ERISA applies to HSA's, expecially if not employer contributions. ERISA may be applicable in manner similar to employer contributory IRA's and 403(b) salary reduction plans
Funding requirement	Not required. There is not any requirement to set funds aside in a separate account; if an employer does so, ERISA's trust requirement may apply.	Not required. Employers may decide to fund (I.e., set aside funds) as potential liability increases. But any such funding may invoke ERISA's trust requirement.	Employer and employee HSA contributions required to put in a trust.
ERISA plan asset issues	Even though a plan may be treated as "unfunded" under ERISA Tech. Rel. 92-1 salary reduction amounts are plan assets for purposes of ERISA's exclusive benefit and fiduciary duty rules.	Generally no plan assets unless funded (I.e., generally no plan assets if all reimbursement paid directly out of general assets of the employer).	For plans with employer contributions, generally non-elective employer contributions would be plan assets once placed in MSA trust. Pre-tax salary reductions and after tax salary reductions would become plan assets as soon as they could be segregated from employer's general assets (generally no longer than a day after they are withheld).
ERISA Form 5500	Applies. Exception for small (fewer than 100 participants) unfunded plan.	Applies. Exception for small (fewer than 100 participants) unfunded plan.	Applies, if there are employer contributions (possibly including pre-tax salary reductions) to the HSA trust.
ERISA, SPD and other disclosures, and adherence to ERISA's benefit claims procedures.	Required	Required	Applies if there are employer contributions. But if claims are self-adjudicated, claims procedures should not apply.
HIPAA
Portability, certificates of creditable coverage, and health status nondiscrimination.	Applies. Exception for most health FSA's funded with salary reductions.	Applies. Health FSA exception generally not available.	Guidance from the DOL regarding whether an HSA is an ERISA plan will be relevant in determining requirements for an HDHP and for anemployersponsored HSA even if sponsored by governmental entity or church.
Privacy	Applies	Applies	Guidance from the DOL regarding whether an HSA is an ERISA plan will be relevant in determining requirements for an HDHP and for anemployer-sponsored HSA even if sponsored by governmental entity or church.
COBRA	Applies. There is a special rule for qualifying health FSA's.	Applies. Special rule for qualifying health FSA's generally not available.	The Code's COBRA provisions do not apply. However, if the employer contributes and/or exerts some control over the HSA it could be subject to ERISA's COBRA. Further guidance is needed from the DOL in determining requirements. Yes for an HDHP.

The above listing is subject to IRS rules and regulations under code section 213 (d).

FOR MORE 213d DETAILS CONTAINED IN IRS PUBLICATION 502 CLICK HERE

Groups of all sizes and their employees can take advantage of any or all of these benefits by following the IRS guidelines. Business Insurance Underwriters is partnered with administrators and financial institutions that specialize in these programs.