For many employers and their employees a flexible health spending account (HSA) is their first introduction to flex. In its simplest form, an HSA (also known as a flexible health expense account) is an individual employee account that reimburses employees for certain medical expenses. Employees select the eligible claims they wish to submit to their HSA and take responsibility for their choices. Health spending accounts may exist alone or in addition to a basic extended health care plan.
A properly structured HSA can be set up to place a ceiling on supplemental health care costs. Since a HSA is defined as a fixed dollar amount, the plan sponsor can budget their benefit spending accurately based on their employee count. An HSA is particularly appropriate for a plan sponsor that wants to control or limit financial outlay on health and or dental benefits.
There are two main sources of funds. Source number one would be from direct employer contributions and the second source would be from money freed up by tradeoffs in other benefit areas.
Plan sponsors might consider reducing the coverage provided under the base plan to a level where only catastrophic coverage would be provided. For example, the plan sponsor might implement a base plan with a $1,000 deductible for drug expenses. In this case each employee might be allotted a $1,300 health spending account. Each employee will have the flexibility to spend the funds in they way that makes most sense for their family situation, but it is possible that they could end up with some out of pocket expenses for drug care should they budget their annual drug consumption incorrectly. This is a simplified example, as consideration would have to be given to the Insurer’s ability to adjudicate combined drug and healthcare deductibles and other system limitations as well as the practical amount of funds that can be made available through the HSA.
HSA’s are suitable for situations where a plan sponsor wants to experiment with some degree of flexibility, without making a commitment to a more extensive flexible benefits program.
A healthcare spending account program is relatively straightforward to administer and its advantages are easily communicated to employees. If the health care spending account is properly structured, payments out of the account represent nontaxable income for employees outside Quebec. Payments are not taxable to the employee if they are made to reimburse eligible medical expenses as defined in Subsection 118.2(2) of the Income Tax Act.
To ensure that employees are provided with nontaxable benefits, the health spending account must also qualify as a private health services plan (PHSP). To meet Canada Revenue Agency’s requirements, the plan must be:
An undertaking of one person. Used to indemnify another person. For an agreed consideration. From a loss or liability in respect of an event. The happening of which is uncertain.
In short, a PHSP must qualify as a contract of insurance and there must be some element of risk. Thus, it is not possible for a PHSP to pay out unused amounts as cash at the end of a year.
But what about employees with an unused account balance at year-end or claims in excess of their account balance? Canada Revenue Agency has indicated that while a carry forward period undoubtedly reduces the risk of loss to the employee, it is their view that a plan which permits the carry forward of either flex credits or eligible medical expenses (but not both) up to a maximum of 12 months will not be disqualified as a PHSP solelyby reason of the carry forward provision in the plan.
Canada Revenue Agency has also said that it will accept a plan that permits the carry forward of unused credits for up to one year following the date of termination, retirement or death. After a year, any remaining credits must be forfeited. This 12-month carry forward option is important as it provides an additional degree of flexibility and gives employees an opportunity to budget and plan for certain elective procedures.
Assuming the employer contribution is appropriate, employees should have little difficulty allocating their account balance within a two-year period. It will be necessary however, to communicate the risk of accumulating a large balance without a timely spending goal in mind. Forfeiture notices must be issued at appropriate intervals to remind employees that amounts remaining in the spending account for more than two years will be lost.
Where an employer allocates an amount to an HSA to be held contingently for an employee’s health care expenses, the amount is not immediately deductible. Instead, employer contributions to a flexible health care spending account that qualifies as a PHSP are deductible only as eligible amounts are paid out.
A wide variety of health-related services may be covered using an HSA. In addition to the health and dental benefits normally covered under a traditional extended health care plan, other benefits that can qualify for taxfree coverage include orthodontics and cosmetic dentistry, aesthetic surgery, weight loss or smoking cessation medication prescribed by a physician, many paramedical services, preferred hospital accommodation, glasses or contact lenses and fertility treatments. Flexible health spending accounts may also be applied to cover health plan deductibles, co-payments and amounts in excess of base plan limits.
The health care alternatives available through the HSA will provide individual employees with an opportunity to optimize and customize their benefits program. Health spending accounts are versatile and tax-effective instruments, but they are not an option to be selected lightly by plan sponsors.
In one sense, HSA’s are merely an exploratory and noncommittal step down the flexible benefits path. In another sense, however, they represent a paradigm shift in the provision of employee benefits. A flexible health spending account is nothing less than a defined contribution employee benefits plan.
Defined contribution may well be the primary cost-containment strategy of the future and health spending accounts might be the bridge that gets employers there. Whether they are used by themselves, used to supplement a core health plan or used as one component in a more comprehensive flexible benefits plan, HSA’s may address both the plan sponsor’s need for cost control and each employee’s need for personalized coverage.