Health Savings Accounts benefit small businesses
Health Savings Accounts are an increasingly popular option, especially for smaller businesses.
By Mark E. Battersby
How many small businesses can afford to offer fringe benefits, let alone good health insurance, to keep or attract good workers? Why, especially in these troubled economic times, are the U.S. Small Business Administration (SBA) and the Internal Revenue Service (IRS) joining together to push Health Savings Accounts (HSAs)? The answer: HSAs may be an affordable option for many small businesses, as well as beneficial to the operation’s owner.
HSAs have become the fastest-growing product in the health benefits industry for good reason. High-deductible health plans dramatically lower health insurance costs for employers, and the employee-owned accounts give users more control and freedom for routine health expenses.
Defining Health Savings Accounts
Health Savings Accounts were created as part of the Medicare Prescription Drug, Improvement and Modernization Act signed into law by President Bush on December 8, 2003, and were first offered in 2004. The high-deductible insurance plans allow employees to contribute to a savings account with pretax dollars. Employers may or may not match employee contributions. Any unused cash belongs to the employees.
An HSA is similar to an Individual Retirement Account (IRA), established to receive tax-favored contributions by—or on behalf of —eligible workers. The difference between an IRA and an HSA is that amounts in an HSA can accumulate over the years and eventually be distributed tax-free to pay medical expenses.
That’s right: Funds may be withdrawn, without penalty, at any time—but only to pay medical expenses. Like contributions to an IRA, funds deposited into an HSA are tax deductible, as are the funds earned by the HSA account.
If a specialty fabrics manufacturer makes the contributions to a worker’s HSA account, those amounts are ignored by the worker for tax purposes. The employer is not required to withhold payroll taxes on contributed amounts, and may deduct them as payments made for a fringe benefit plan.
On the downside, in order to qualify for an HSA, a so-called “high deductible” medical insurance plan is a necessity. And there are limits on the amounts that may be contributed to an HSA each year. In the 2008 tax year, for example, an individual could contribute up to $2,900, an amount that increases to $3,000 in 2009.
An individual with family coverage is allowed a contribution of $5,800 for 2008 and $5,950 in 2009. So-called “catch-up” contributions are available for those who are age 55 or older, at $900 in 2008 and $1,000 in 2009.
Exploring High-deductible health plans (HDHP)
Generally, a high-deductible health plan is one that satisfies certain requirements as to deductibles and out-of-pocket expenses. For 2008, the minimum annual deductible amount will remain at least $1,100 for self-only coverage or $2,200 for family coverage.
In addition, the annual out-of-pocket expenses under the HDHP cannot exceed $5,500 for self-only coverage or $11,000 for family coverage. Out-of-pocket expenses include deductibles, co-payments and other amounts (other than premiums) paid for plan benefits.
For those with HSA plans, amounts contributed are tax deductible for determining adjusted gross income, the amount used to figure personal income tax. The maximum total annual contribution to an HSA is the lesser of (1) 100 percent of the annual deductible for the high-deductible health plan, or (2) the statutory maximum as adjusted for inflation. Excess contributions are included in gross income and subject to a six-percent excise tax.
Workers can sign up for HSAs with banks, credit unions, insurance companies and other approved organizations. Employers may set up a plan for employees as well.
Businesses investigate use of HSAs
Businesses approve HSAs because they help shift health care costs to employees, which is why more than half of large company plans currently offer an HSA as an insurance option. Often, in those larger companies (5,000+ employees), only 10 to 20 percent of employees sign up. Usage is generally higher in smaller businesses, where an HSA might be the only health insurance option
The SBA and the IRS are currently promoting HSAs as an important option for health care coverage, an option that allows thousands of employers to provide their employees coverage they might otherwise not be able to afford. A small business owner who wants to provide employees with affordable health care should keep in mind a few points:
- HSAs allow both employers and employees to contribute, unlike earlier health savings vehicles.
- HSAs share the cost of health care benefits with employees in a way that benefits both them and the employer.
- HSAs avoid administrative costs because employees self-administer their HSA. There are minimal administrative costs for the employer.
- A business can contribute in a lump sum, or at any time, to an employee’s HSA; no minimum contributions are required.
- HSA funds are an asset that the employees own, so they can use it to supplement their retirement income and build personal wealth and financial security.
For employers wishing to simplify health insurance as a benefit, an increasingly popular approach is to provide employees with a fixed dollar amount per month for buying health insurance and making HSA contributions. This requires minimal administration, since employees choose a plan on their own. This approach, known as “defined contribution,” maximizes employee control and provides significant employer savings.
HSAs offer advantages for employees
Although the deductible is high—averaging $1,500 for individuals and $3,000 for families—HSAs do not skimp on coverage. Plans usually pay 100 percent of all medical expenses once the deductible amount has been reached, as well as paying preventive-care costs. There are no co-payments.
Another perk: A worker who is generally healthy and doesn’t rack up many bills can stash a lot of money in an HSA. On the downside, although consumer-driven health care sounds great on paper, it can be difficult.
There is evidence that enrollment in HSA plans has grown not only because the plans offer greater value but because they are often the only plans that customers can afford—and sometimes the only plans an insurer will offer applicants with chronic conditions such as asthma, diabetes or depression.
Perhaps the scariest thing about HSAs is the market risk. HSAs work like a 401(k) plan, which means the proceeds are invested in a mutual fund or other savings vehicle. Most HSA plans offer four to eight investment options, including stock funds, but keep in mind the volatility of the markets.
Companies and employees calculate tax deductions for HSAs
A self-employed fabricator may deduct from his or her gross income 100 percent of amounts paid for health insurance for themselves, spouses and dependents. The deduction cannot exceed the net income from the activity (minus 50 percent of self-employment tax and/or contributions to qualified retirement plans).
The tax treatment of fringe benefits paid to employees of an S corporation is different for owner-employees than for other employees. Fringe benefits paid to S corporation employees who are not shareholders, or who own 2 percent or less of the outstanding S corporation stock, are tax-free. They can be excluded from the employee’s taxable wages and are deductible as fringe benefits by the S corporation.
Employee-owners owning more than 2 percent of the S corporation stock, on the other hand, are not treated as employees for fringe benefit purposes, and their fringe benefits may not be tax-free. Generally, such owners are treated in the same manner as partners in a partnership.
In other words, a payment of premiums by a partnership for a partner’s health or accident insurance is generally deductible by the partnership and included in the partner’s gross income. As an alternative, a partnership may choose to account for premiums paid for a partner’s insurance by reducing that partner’s distributions; in this case, the premiums are not deductible by the partnership and all partners’ distributive shares are unaffected by payment of the premiums.
A partner can deduct 100 percent of the cost of health insurance premiums paid on his behalf. Similarly, an owner-employee who owns more than 2 percent of the S corporation stock can deduct 100 percent of the amount paid for medical insurance for himself, his spouse and dependents.
Critics and proponents discuss HSAs
Proponents contend that the lower premiums of the health plans and the tax-free savings potential of HSAs have justifiable appeal to consumers, while the health plans’ high deductibles encourage enrollees to be more astute health care consumers.
Critics, however, are concerned that HSA-eligible plans may attract enrollees who seek lower premiums but lack the resources to contribute to an HSA, as well as wealthy enrollees who may use the HSA primarily to accumulate tax-advantaged savings.
Congress’s watchdog agency, the Government Accountability Office (GAO), recently found that the number of individuals participating in HSA-eligible high-deductible health plans and HSAs has increased significantly since their introduction in 2004. The number of people covered by HSA-eligible plans has increased from 438,000 in September 2004 to an estimated 6.1 million in January 2008
An HSA plan can be right for both your business and your employees, but you should assess your needs (and theirs) very carefully when making this a health care option.
