Health Spending Accounts
Advantages for the Employer
If I was talking to a business owner about setting up a health spending account, I could tell them that they determine how much they are willing to spend each year and have greater control over the funding of a Health Spending Account program than they do in a traditional plan design. This is very attractive to any business dealing with uncertain revenues and the need to control its expenses.
A second attractive feature of Health Spending Accounts is the flexibility in the funding model. It is easy to enable employees to participate in funding part of their supplementary medical expenses. Once a year on a pre-established date, an employee can ask to have part of their compensation applied to the Health Spending Account. The amount will be deducted from the employee’s income and will not be taxed as employment income. This provides a 100% tax shelter on those funds. This is highly advantageous to the employee if they know an expense is coming up (orthodontic expenses, for example) that they want to fund using pre-tax dollars. The employer is a good model because they are not forcing the employee to participate in the funding of supplemental medical expenses. In addition, the employee’s participation in funding is optional. This feature allows employees to fund at a higher level without the employer having to increase their spending on this employee benefit.
One additional benefit to an employer is that they can set up the Health Spending Account. Unused contributions from the employer revert to the employer if not used within a specific time frame by the employee. This becomes taxable revenue to the employer when it reverts as it had been deducted from revenue as a tax-deductible expense when the contribution was made to the Health Spending Account.
Health Spending Accounts
Advantages for the Employee
A Health Spending Account can often pay more of an employee’s supplementary medical expenses than a traditional plan. In traditional plan structures, benefit payments are usually reduced by co-insurance, deductibles, benefit sub-limits and dispensing fees. Health Spending Accounts do not normally have any of these limitations.
For example, let’s look at a traditional benefits plan with 80% co-insurance and a dispensing fee limitation of $6.50. If an employee had a $150.00 prescription drug bill with a $10.00 dispensing fee, the insurer would pay $120.00 plus $6.50 of the dispensing fee for a total of $126.50. The employee would pay $30.00 of the prescription cost plus $3.50 of the dispensing fee for a total out-of-pocket of $33.50. Under a health spending account, the plan would pay $160.00, and the employee would pay $0.00. In this scenario, the Health Spending Account is more attractive to an employee than the traditional plan.
A Health Spending Account can also be used to pay expenses not covered under a spouse’s benefits plan. In the above example, if the employee’s spouse had the traditional benefits plan described above, the employee with the Health Spending Account could use the Health Spending Account to pay the $30.00 co-insurance payment and the $3.50 dispensing fee, which would reduce their out of pocket expense to $0.00. Although it is possible to gain a contribution payment from the other spouse’s plan if both employees had full traditional benefit plans, it is far less complicated administratively when one of the plans is a Health Spending Account. Under the coordination of benefits guidelines, group plans pay their benefits first before a Health Spending Account is required to contribute. The coordination of benefits payment when there are two group plans are complicated and can create gaps in coverage due to the complexity of applying different deductibles, co-insurance, per visit, and per year maximums from two different plans. The simple payment structure under a Health Spending Account avoids many of these problems. It also saves the employer with the Health Spending Account money because the traditional plan pays first under the current coordination of benefits rules adopted by the Canadian Life and Health Insurance Association.
The payments under a Health Spending Account can be broader than a traditional plan. Although the payments under a Health Spending Account are limited to products and services eligible for deduction under the tax act, this is generally much broader in scope than what is defined as covered under a traditional benefits plan. In many specific situations, this can be beneficial to employees.
As mentioned above, if an employee knows that a large expense is on the horizon covered under the Health Spending Account, they can negotiate to fund the additional expense from their salary as a contribution to the Health Spending Account. But, again, this is a tax beneficial option not usually available under a traditional benefits plan.
When we add up the advantages of a Health Spending Account compared to a traditional benefits plan, it seems to stack up overwhelming in favour of the Health Spending Account for both the employer and the employee. But keep reading; there is more to the story.
The Disadvantages of Health Spending Accounts
There are only a couple of disadvantages of a Health Spending Account, and they mostly impact the employee, not the employer. But the disadvantages are major and quickly swing the pendulum back in the other direction.
Compared to a traditional plan, the biggest disadvantage of a Health Spending Account is the lack of catastrophic prescription drug protection. The Health Spending Account will not pay more than the amount that is funded. In the instances of many employees, that is adequate, but for the unfortunate few who could be facing a drug bill of over $10,000 or $20,000 per year, the lack of coverage under a Health Spending Account can be devastating. It has been pointed out to me many times that every province has a catastrophic drug plan that the employee can access if their insurance coverage and Health Spending Account funding is exhausted. But the provincial plans often have a deductible that is subject to a means test. So depending on an employee’s level of household income, the deductible can be relatively small or quite large. In either event, as it is based on the income, the deductible is a real financial burden for the family that is incurring high prescription drug costs.
The other significant disadvantage of a Health Spending Account is the lack of a pay direct drug card. For employees, this can be an important issue. Pay direct drug cards have been very helpful to families who are stressed financially. The lack of a pay direct card under a Health Spending Account means the employee has to fund the cost of prescription drugs and then wait for reimbursement. If money is tight, this is an unwanted burden.
As I mentioned earlier, these two issues are really primarily disadvantaged to the employee, not the employer. But employers are also concerned about these issues because it affects employee recruiting and retention. So the quality of employee benefits is important to employees.
In the future instalments of this series, I will examine options for dealing with the limitations of Health Spending Accounts and provide examples of how they have been used successfully. Also, I will make some predictions of this product and traditional benefit plan designs.
Chris Coulter is the Founder and President of The Finish Line Group. He works with business owners to leverage their businesses to increase their wealth, reduce corporate and personal taxes, create viable succession strategies, enable employee retention strategies and allow them to exit their businesses on their terms.
Chris’ passion for what he does evolve from the mistakes he made in his first business; by not diversifying his risk and not utilizing many opportunities within his business to create significant wealth. Chris found out the difficult way and now educates business owners on avoiding many of his former oversights and ultimately controlling where their finish line ends.
Setting Up A Health Spending Account
