Accessorizing Your Health Savings Account Program

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“A growing number of Health Savings Account owners are building balances to fund qualified expenses in retirement, including Medicare cost-sharing, Medicare premiums, and services (like dental and vision) not covered by Medicare. If they fund a Limited-Purpose Health FSA, they can enjoy the same tax benefits as a withdrawal from a Health Savings Account as they preserve those balances for their future selves.”

William G. (Bill) Stuart

Director of Strategy and Compliance

October 29, 2020

Many smaller companies are scrambling to finalize their 2021 benefits offerings. Depending on premium increases, this may be a time of relief or anxiety. If anxiety is reigning, it’s time to look at some innovative approaches to managing premium costs. Strategically employing a limited Health Reimbursement Arrangement may help rein in premiums. And companies looking to enhance their employees’ medical options and retirement offerings may find value in offering a limited Health FSA that benefits both employers and participating employees.

Health FSAs and HRAs are subject to certain rules and definitions of medical plans under federal tax law. That’s a problem when it comes to employees’ eligibility to fund their Health Savings Accounts, since general Health FSAs and HRAs reimburse the first dollars of qualified medical expenses. As such, they represent disqualifying coverage, and an employee who participates (or whose spouse is enrolled) in either plan can’t make or receive contributions to a Health Savings Account.

But each of these programs includes at least one variation that can be integrated into an employer-sponsored medical program to ease the financial burden on employer and employee.

Let’s look at how an employer can accessorize its Health Savings Account program and how employees can enhance their financial look by participating.

Post-Deductible HRA

A Post-Deductible HRA begins to reimburse deductible expenses after the employee has assumed responsibility for $1,400 or more self-only coverage or $2,800 or more for family coverage. This plan design doesn’t disqualify employees because it complies with the rules for HSA-qualified coverage by not reimbursing any expenses before the $1,400/$2,800 minimum deductible in 2021.

How does it work? Let’s say the company has a $1,500 self-only deductible now. It could switch on anniversary to a plan with a $3,000 deductible and reimburse the back half of the deductible with a Post-Deductible HRA. The company would lock in lower premiums. It would then fund the Post-Deductible HRA to pay all claims above $1,500.

In this model, employers and employees save on premiums. Employees’ out-of-pocket responsibility doesn’t change. And the addition of the Post-Deductible HRA doesn’t affect the employer’s or employees’ opportunity to fund employees’ Health Savings Accounts to the federal limits of $3,600 for self-only and $7,200 for family coverage in 2021, plus another $1,000 if age 55 or older.

Yes, the employer runs the risk that the entire premium savings – and perhaps more – are needed to fund reimbursements from the Post-Deductible HRA. But that’s rarely the case. Even when the company has bad claims experience on its medical plan, the driver is usually a handful of high-cost claimants rather than high claims spread across the population.

A generous employer can offer the Post-Deductible HRA to eliminate employees’ deductible responsibility beyond a certain point ($1,500 in the example above) and simultaneously contribute to their Health Savings Accounts. They can contribute a portion of employees’ net deductible, the entire amount, or even more (up to the statutory limit on contributions listed above). Employer funds in the Post-Deductible HRA don’t offset Health Savings Account contribution limits, but the company contribution to employees’ Health Savings Accounts do count against the $3,600/$7,200 ceiling.

Offering a Post-Deductible HRA is a quick and painless way of offering comparable coverage with a lower premium. That saves both employer and employee money. Employer savings are at risk as payments from the HRA to employees who incur high claims. But total reimbursements from a Post-Deductible HRA are almost always less than premium savings.

By the way, this strategy works equally well in a non-HSA-qualified environment. Many companies use a back-end HRA that begins to reimburse claims after employees reach a certain deductible threshold.

Limited-Purpose Health FSA

The Limited-Purpose Health FSA reimburses dental and vision expenses only, plus select preventive services that aren’t covered in full. These same services can be reimbursed tax-free from a Health Savings Account as well.

So, what’s the benefit of offering a Limited-Purpose Health FSA? Employers benefit because every dollar of incremental employee contribution (an additional tax-deferred amount, rather than redirecting a payroll deduction from one account to another) reduces the company’s payroll-tax liability. That’s a savings of 7.65% (on income below $137,700 in 2020, and 1.45% on income above that figure). Thus, an employee who elects $2,000 into a Limited-Purpose Health FSA to pay for dental work saves the company $153 in payroll taxes.

For employees, there are four distinct benefits:

More tax savings. An employee who contributes the maximum to her Health Savings Account can elect up to an additional $2,750 into a Limited-Purpose Health FSA. Assuming a 27% tax rate, this election generates about $750 in additional tax savings.

Immediate access to funds. Health FSA funds are available immediately, not as payroll deductions accumulate. Participants can spend their entire election at any time during the year. When balances are spent early, the account becomes an interest-free loan repaid with level payroll deductions during the balance of the year. An employee undergoing expensive services – think vision-correction surgery, restorative dental work, or orthodontia – early in the year has the bargaining power to secure a cash discount by paying for services up-front.

Medical equity. A growing number of Health Savings Account owners are building balances to fund qualified expenses in retirement, including Medicare cost-sharing, Medicare premiums, and services (like dental and vision) not covered by Medicare. If they fund a Limited-Purpose Health FSA, they can enjoy the same tax benefits as a withdrawal from a Health Savings Account as they preserve those balances for their future selves.

Certain children’s expenses. Health FSAs follow certain federal rules that apply to medical coverage, whereas  Health Savings Accounts don’t. Medical plans must cover children to age 26, even if they’re no longer a parent’s tax dependent. Thus, parents can reimburse their non-dependent children’s qualified expenses tax-free from a Health FSA. In contrast, Health Savings Account distributions are tax-free only if the family member who incurs the expense is a tax dependent. Thus, a parent who wants to help a 24-year-old child living on her own with an expensive dental or vision purchase can fund a Limited-Purpose Health FSA and reimburse the expense tax-free.

The Limited-Purpose Health FSA That Expands

Some Limited-Purpose Health FSAs are more limited than others. Employers can choose to offer a plan that opens to the broader list of Health FSA qualified expenses.

Here’s how it works: Once a participant attests that he has incurred at least the statutory minimum annual deductible level ($1,400 for self-only and $2,800 for family coverage), the Limited-Purpose Health FSA morphs into a traditional Health FSA. At that point and beyond, the participant can reimburse not only qualified dental and vision but also qualified medical, prescription drug, and over-the-counter expenses from the account.

Employees can use this account strategically. For example, I haven’t used any of my $2,750 election so far this year. I have preserved it to pay for the back half of my family’s deductible expenses (my plan has a $6,000 family deductible). This use represents a risk – that we don’t incur high expenses. That looks like the case this year.

But a family member needs some expensive dental work. So, enrolling in the Limited-Purpose Health FSA, with its use-it-or-lose-it feature, isn’t a risk to me. If we have high deductible expenses, the Limited-Purpose Health FSA funds will pay those bills. If we don’t, we do the major dental work this year rather than next year (with a new election).

The only way I “lose” financially is if we use the funds in early December for the dental work and then we incur high deductible expenses late in December. Then, I must choose between enjoying tax savings (withdraw funds from my Health Savings Account, which I’m loath to do – I’m a prodigious saver) and paying the bills with after-tax funds.

Enrolling in a Limited-Purpose Health FSA solely to protect against the possibility of high deductible expenses is risky. But if you have qualified dental and vision expenses whose timing can be adjusted between the end of one year and the beginning of the next, the risk is minimal.

Employers choose whether to offer a straight-up Limited-Purpose Health FSA or to allow the plan to expand for employees who meet the deductible threshold.

Caveats

For employers, there’s little risk in offering a Limited-Purpose Health FSA, particularly if the company sponsors a general Health FSA. The cost of offering the additional program is minimal, and the payroll-tax savings typically more than cover the investment.

Employers accept the risk that participants will leave employment having spent more than the company has deducted from their paychecks – a risk inherent in all Health FSA plans. They face another risk: failing nondiscrimination testing. That’s the annual test required of all Cafeteria Plan programs (like Health FSAs, Health Savings Accounts, and Dependent Care FSAs) to make sure that benefits don’t flow disproportionately to high-income employees. If the only participants in the Limited-Purpose Health FSA program make high elections, and if they represent a large share of the company’s overall Health FSA participation, they may cause a failure. But testing early in the plan year can lead to quick corrective action.

Participants face the risk that their need for funds will increase or decrease during the year, and they can’t change their elections without a qualifying event. They’re part of the fabric of Health FSAs. But Health Savings Account owners can adjust their contributions as their needs change, and they don’t risk forfeiting balances at years’ end.

Bottom Line

Health FSAs help employees manage their medical budgets, with spillover benefits to employers (no payroll taxes on elections). HRAs help employers manage premium costs, with substantial benefits to employees (less of their paycheck deducted as their share of premiums, and less of the company’s compensation budget consumed by its share of premiums). Both programs can play an important role in managing costs, as well as employee financial anxiety. And variations of both fit nicely into a robust Health Savings Account program.

What We’re Reading

What are voters thinking about medical coverage and healthcare issues as they head to early voting or the polls on election day? The Commonwealth Fund provides some answers here.

Since the early primaries, a key campaign issue has been changed to the design, delivery, and financing of medical care in the United States. But there are other ideas, not always expressed as concise policy options, to create a system that puts patients and doctors at the forefront. The Galen Institute offers one such plan here.

Thinking about early (or traditional) retirement and own a Health Savings Account? Here is some helpful information to incorporate into your timing strategy.

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