Health spending account use is rising

Since both kids had autism, Carolyn Plummer and her husband needed to drum up as much as $40,000 a year to cover treatment costs. And when they placed one of the kids in a special education class, those costs skyrocketed further.

Three years ago, Plummer’s husband – an incorporated business owner – set up a health spending account. Ever since, their treatment-related expenditure has dipped by 30%. The HSA has not only covered various aspects of their kids’ treatment, it has also allowed them to claim the full tuition amount as a medical expense.

A health spending account works like a bank account you can draw from, only it is for medical and health-related expenses not covered by the rest of your benefit plan and/or your spouse’s benefit plan.

Typically, Plummer explains, extended healthcare plans cover just occupational therapy and speech therapy fees for her kids, both of which cap at $500. “But a psychologist can cost up to $175 per hour; occupational therapy can cost $125 for an hour. The money runs out in a month.” The biggest expense – behavioral intervention – isn’t even covered.

Most traditional plans don’t accommodate a roster of treatments such as autism, fertility, orthodontia, cosmetic procedures, or in some cases, obesity or smoking cessation. And the government gradually keeps delisting more and more services – chiropractic treatment, eye care, and physiotherapy are already restricted to some extent.

The HSA is funded by the employer using pre-tax dollars that the employee uses to pay for eligible health-related expenses. Because no income tax is paid on these dollars, the purchasing power of a $600 HSA is actually $600, as opposed to $780 ($600+30% tax).

Coverage not only includes everyone covered by a current benefit plan [DASH] spouse and children – but anyone declared on an income tax form as a dependant, such as an ex-wife or elderly parents.

You don’t have to use the entire allocated amount during the year. Unused dollars are added, or rolled over to the new year’s total. However, the rollover for any one year can be rolled over only once. And if you leave an employer, the funds belong to you, even if you choose to leave the company.

Powerful tax tool

Ever-rising insurance premiums and limited healthcare options are forcing more and more employers to shift from defined benefit to defined contribution plans to retain a sense of budget certainty in these uncertain times.

According to Marla Schwartz, co-president of Benecaid, a Toronto-based health benefits administration company, in this recession-ravaged environment, health spending accounts can also be a potent tax-saving and employee-retention tool. By contributing to employee health spending accounts, participating employers get a business deduction. HSAs can be set by class, seniority or salary and can also serve as an attractive form of bonus for preferred employees. Employers can define separate rates for singles or families.

Schwartz has seen a substantial increase in HSA inquiries over the last two years because a lot of small business owners are becoming frustrated with the structure of benefit plans – their sheer inflexibility and specificity, lack of control and escalating premium increases year-in and year-out. “When economic times were good, it wasn’t such a big deal. But when they are difficult, and you have a completely uncontrollable cost line in your income statement, it’s a real problem.”

In 2008, Benecaid saved new companies that went the [HSA route an average of $817 per employee], Schwartz says. “In traditional insurance . . . if the employee maximizes the use of their plans, the premium for the employer goes up 20-30%, that’s pretty significant.”

Doug Wellman, president of Wellman Financial, agrees HSAs have become increasingly popular over the past couple of years, and everybody wants to hear about them. “Canadians tend to be cautious and conservative by nature. When we didn’t have 20% to 30% premium increases year after year, it just wasn’t an issue. People didn’t think about it. Now people are really starting to focus on cost.” Advisors, he recommends, should talk to clients who are business owners, it’s a great door opener. “The best candidate is an incorporated business typically with one to 30 employees.”

Wellman who gives the HSA option to all his clients – to business owners for themselves and their key executives – recommends a typical candidate for HSAs is an incorporated employer whose staff size ranges from one to 50, and who wants to look after employees but can’t afford uncontrollable business expenses.

Schwartz, who used her HSA for Lasik eye surgery, adds HSAs make sense for anybody who doesn’t have a benefit plan at work, and has medical expenses that can’t be written off. By funneling expenses through a HSA, they can get tax deductions. It also makes sense for people who do have a benefit plan but it doesn’t cover procedures they require, such as crowns, braces, laser eye surgery or cosmetic surgery etc.

The HSA is also an efficient way for the self-employed – whether incorporated, or not incorporated – to tax effectively deduct medical expenses, Schwartz says. “If you’re not in a benefit plan, medical expenses are a tax credit on the income tax return, and it isn’t a 100% deduction. If you can put money into this account and set up with a administrator like Benecaid, eligible medical expenses will be 100% tax deductible.”

It translates into a 35% saving for employees under the highest marginal tax bracket in ON.

The rules are different for the self employed and unincorporated: An adult can contribute up to $1,500, and an additional $750 per dependant child under 18, and has a up to two years to spend the funds on all listed participants.

What Plummer likes best about these accounts is the flexibility to determine how much to allocate to the account every month. “When the tuition fee for my kid is due, most of the time we’ve already accrued the money.”

And while employers can put a flat sum of money into an employee’s health spending account and not worry about annual premium fluctuations, employees can express their unique wants and needs by controlling what their health budget is spent on.

“Insurance works best when the probability of something occurring is low but the financial consequence is high. However, more than 90% of medical and dental expenses covered by employee health plans are predictable and can be budgeted for rather than insured. It’s silly to buy insurance for a regular dental checkup because you expect to go every year,” notes Schwartz.

New kid on the block

While HSAs have been available since 1986, Wellman says there’s still a gap in knowledge, and even professionals aren’t aware of the opportunity. “That’s because only in the last three years have providers made the paperwork simple.” Prior to that, the process was somewhat cumbersome. “To follow the CRA mandate required setting up a health and welfare trust, which could involve a lawyer and lots of paperwork,” Wellman suggests.

A similar previous arrangement that insurance companies provided key executives – Cost Plus – got into a legal battle with the CRA (Spicy Sports Inc. v. R, 2004), and lost. “That has made this arrangement a little suspect,” he notes.

In the Spicy Sports case, the shareholder-employee was reimbursed by his employer (the company he owned) for elective knee surgery performed in the United States at a cost of approximately $38,000. The CRA auditor determined that the shareholder-employee received payment under the Cost Plus arrangement in his role as shareholder, not as an employee.

The court upheld the auditor’s decision, concluding it was unlikely the company would have provided the Cost Plus plan to an arm’s length employee. As such, the payment in question was categorized as a payment to a shareholder and not as a payment to an employee under a private health services plan. As a result, not only was the payment to the shareholder fully taxable, the company could not deduct the payment from its income.

When an employee-shareholder receives a benefit under a Cost Plus plan, there’s a presumption that the shareholder-employee receives the payment by virtue of his or her shareholdings in situations where the shareholder can significantly influence business policy.

“HSA, which is a federal program, makes it legal. So a lot of advisors are now recommending the HSA route rather than Cost Plus,” Wellman says. CRA sets the rules for health standard accounts, and they are pretty standard across the country.

Not for everyone

However, just because they’re flexible and a great tax-saving vehicle doesn’t mean they’re great for everybody.

The HSA can only be accessed for qualified health expenditures. If not, it just sits in the account. “So there’s no incentive to put more into an HSA because it isn’t an investment account, there’s no interest on the balance. It can’t even be transferred to another’s name,” Schwartz explains.

“If you’re 20 and in perfect shape, and your employer offers a choice between HSA and RSP, maybe RSP is a better choice for you.”