While many employers might see health insurance as an unnecessary expense, up to 55% of employees consider this sponsored benefit to be a prime contributor to their overall job satisfaction. As a result, businesses that offer health insurance are likely to have more skilled, productive and engaged workforces. Health insurance also creates significant tax savings for businesses, as relevant employer contributions are tax-deductible while a share of the corresponding employee contributions can be subtracted from the overall payroll tax liability.
Of course, even if these advantages didn’t exist, a large portion of employers would still be required to offer health insurance due to the Affordable Care Act, which states that any organization with more than 50 full-time employees must provide a medical care plan for its workers. However, the rising cost of healthcare has made it increasingly difficult to abide by these terms. A survey from the National Business Group on Health (NBGH) estimates that the average annual cost of health insurance for a single employee comes out to $14,099, this figure is forecasted to rise by another $700 over the next year. Employers are currently expected to pay around 70% of this sum while employees cover the remaining 30%.
Business owners have tried to find ways to rebalance this equation by opting for alternative benefits models where employees pay higher deductibles or make a more substantial contribution to their insurance premiums. While these options can help to minimize healthcare expenditure, they also create new cost pressures for the employees in question. The additional burden may well negate any benefits that would otherwise come from offering a sponsored health insurance plan. In these cases, businesses can offer flexible savings accounts (FSA) and health savings accounts (HAS) to help employees manage the cost of their health insurance more effectively.
What Are Health Savings Accounts?
HSAs and FSAs are cafeteria plans that are governed under IRS Section 125. Any contributions to these plans are made pre-tax, so they can help employees to retain a larger portion of their income. All funds and related earnings gathered through health savings accounts are tax-free. However, the money can only be used to cover qualifying medical expenses. HSA/FSA withdrawals can be made through a debit card that automatically retrieves the underlying funds, or patients can submit medical receipts and receive reimbursement for their out-of-pocket expenses.
Items which qualify for HSA/FSA withdrawals can include:
- Dental treatments.
- Prescription medications.
- Reconstructive surgery.
- Long-term palliative care.
- Psychiatric care.
- Various forms of therapy.
- Specialized medical equipment.
- Eye exams.
- Copays and deductibles.
The following expenses would not qualify for tax-free HSA/FSA withdrawals.
- Cosmetic surgeries.
- Hair removal.
- Veterinary fees.
- Weight-loss treatments.
- Domestic assistance.
Funds that are used to cover non-qualifying medical expenses are taxed at 20% plus an additional early withdrawal penalty for individuals under 65. From 65 onwards these penalties are removed, however account holders are still liable for any related income taxes.
What is an HSA?
Only individuals and families that are enrolled in high deductible health plans (HDHP) are eligible for enrolment in HSAs. In 2018 the qualifying criteria for an individual HDHP is any plan that has a minimum deductible of $1300, annual out-of-pocket expenses for this plan cannot exceed $6500. Meanwhile, a family HDHP must have a minimum deductible of 2600, and the maximum out-of-pocket expenses cannot exceed $13,100. Qualifying individuals cannot be listed as dependents on any other person’s tax return, and they may not be enrolled in Medicare or any other conflicting health insurance plan. Eligible self-employed individuals can also open HSAs through their health insurance provider or bank.
Employers can also choose to make additional donations to their employees’ HSA. These contributions will also be tax-free. As of 2018, the maximum allowed contribution to an HSA is $3400 for individuals and $6750 for families. From the age of 55, individuals can contribute an additional $100 to their account while family HAS plans allow additional $1000 contributions from both you and your spouse. The employee can decide how much they contribute to their HSAs in any given year.
It should be noted that employees will remain as the ultimate owners and administrators of their HSAs, which means that they will retain control of all deposited funds even after they leave a specific company. Employees are also not required to provide receipts or any other form of proof to their employers before withdrawing funds from their HSAs. However, they must maintain adequate records and report their distributions on Form 8889 for health savings accounts. Any unused HSA funds will simply be rolled over to the next year, so there is no risk of losing unspent money.
What is an FSA
Flexible spending accounts are owned and administered by employers, and they can be paired with any existing healthcare plan. You cannot open an FSA unless you have been offered this option by your employer. All employees are eligible for FSAs unless they already operate HSAs as well. However, these individuals may be offered limited purpose FSAs (LPFSA). These plans are used to cover specific medical expenses (dental treatment, vision treatment). LPSFAs are generally only useful for people with high annual medical costs that want to minimize withdrawals from their HAS. Tax-free withdrawals for FSAs are generally limited to medical expenses that are not otherwise covered by your health insurance plan, however eligible expenses may differ from plan to plan.
In 2018, the maximum allowable contribution to an FSA is $2650. Again, contributions can be made by both the employee and employer. In an FSA, the employee must specify the amount that they will contribute to their account every year at the time of initial enrolment. This amount can only be adjusted if the employee changes their employment or familial status. However, the employee can withdraw this amount from their FSA at any point during the year, regardless of whether they have made their contribution or not.
In most cases FSA funds are subjected to a use it or lose it policy. Essentially, this means that employees must use their funds by the end of the year or all savings will be forfeited. However, an employer can choose to extend these limits in a number of ways.
- The employee may be offered an additional 2.5 months in which they can make necessary withdrawals. Any funds that are left over after this point are confiscated by the employer.
- The employee may be offered the option to rollover a certain amount of their unused funds to next year’s plan. Again, leftover funds will be confiscated.
As these accounts are operated entirely by employers, employees are required to show detailed proof of expenditure before reimbursements are released. Appropriate documentation includes: a signed statement from a medically qualified independent third party, an invoice detailing the specific expenses incurred, and another signed statement verifying that the related expense is not covered another health insurance plan.
Because these plans are employer-owned, they cannot be carried over from one job to another. However, under the terms of COBRA any employer who employs more than 20 employees is required to continue FSA coverage of an individual, if they would otherwise lose access to health insurance due to termination from their current place of employment.
Which Health Savings Account to Choose?
From an employer’s perspective an HSA is a more cost effective option for healthcare expense management. These plans are generally easier to set up and require less documentation for compliance purposes. From an employee perspective these plans may also be preferable for a number of reasons:
- An HSA is essentially the medical equivalent of a long-term retirement savings accounts such as 401(k). These plans generally come with added investment options, so employees can decide where they want to put their funds in order to earn maximum returns.
- Unlike FSAs, HSAs allow individuals to make withdrawals for non-medical reasons. While these withdrawals are subject to a 20% penalty alongside any due income tax, all deposits and subsequent earnings are tax-free. This flexibility is a big factor in the choice health savings account.
- Adding to this, the fact that HSAs are completely under an employee’s control makes them far more appealing in the long term, as employees do not have to worry about using their funds before the end of the year. Nor do they need to concerned about losing access to their savings if they leave their current place of employment.
- The fact that HSA contributions can be increased after the age of 55, and that all withdrawals are tax-free after 65 makes them ideal for retirement purposes. Once an individual reaches the age of 65, they can also use their HSA funds to pay for Medicare premiums, these withdrawals will be tax-free.
- The employer matching aspect of these plans is another added benefit for individuals that are looking to build a substantial retirement fund.
- Funds from one health savings account can be rolled over into another HSA that offers lower fees and more attractive investment options.
- At a very basic level, HSAs allow much larger contributions which maximizes the amount of money you can put towards medical expenses.
One of the biggest benefits that employers gain from FSAs is that they are allowed to forfeit unused funds from these accounts. At the same time, employers must be wary of the fact that employees can withdraw the full amount of their annual FSA limit without making any contributions for the year. This means that employers must keep enough liquid funds to pay off any reimbursements from this account; otherwise they may face a sudden cash shortage.
From an employee perspective, there are various factors to consider before opting for an FSA.
- If an employee has regular recurring medical expenses from year to year then these accounts may be more appropriate, as the employee can plan their contributions accordingly.
- The recurring nature of these withdrawals will also ensure that the employee does not have to worry about the use it or lose it rule.
- FSA accounts do not earn any interest, but they also will not incur any administrative deductions.
- An employer may only be willing to provide matching contributions to either the FSA or HSA. This may influence the employee’s final decision of which account to opt for.
For employers, the choice between an HSA and FSA is largely dependent on the specific needs of their employees as well as the relevant cost of setting up and administering each of these plans in-house. If you need help determining the best savings account plan for your employees then we’re here to help. You can Get in touch with us online via our contact form, or call us at (732) 458-3800 to get $100 off on your payroll services.