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Consumer-Directed Health Plans

Consumer-Directed Health Plans

The future of health care is here and it’s called “consumerism,” the same principle that drives your choice of supermarket each week. As food prices soar, you think more carefully about how much money you have to spend and which stores offer the best deals on the highest quality food. Consumerism in health care is no different. If you were given $1,000 to buy your groceries for a year, you would study the weekly supermarket flyers, clip coupons, and forgo the extras. This is exactly the same kind of consumer-driven behavior that health policy experts are hoping will curb runaway health care costs.

This is a fundamental shift away from the strict managed care plans that shielded us from the true costs and consequences of our health care decisions. Not long ago, we could get a brand name cholesterol-lowering prescription drug for a $10 co-pay rather than ask our doctors to prescribe the lower-cost generic. Today, under a consumer-directed health plan, our portion of the cost of that drug is likely to be closer to $100, an incentive for us to seek out lower-cost alternatives.

Health Accounts

Most consumer-directed health plans feature health accounts that allow you to control a portion of your own health care dollars and pay directly for routine medical needs such as doctor visits and prescription drugs. They are intended to be used to help pay for out-of-pocket medical expenses or when working in tandem with a high-deductible health plan (HDHP), to pay for smaller medical expenses until your deductible is met. Once your deductible is met, your insurance begins paying for covered benefits.

Both health reimbursement arrangements (HRAs) and health savings accounts (HSAs) are tax preferred alternatives to traditional health insurance products that create incentives for you to weigh your health care spending options. Both are similar to flexible spending accounts (FSAs), except there is no “use it or lose it” rule. Balances roll over from one year to the next. However, there is one fundamental difference between the two. An employer owns your HRA; you own your HSA. However, if you are self-employed, you are the company – so you own the HRA, too. 
 

Health Reimbursement Arrangements (HRAs)

If you are a micro-business or self-employed, Health Reimbursement Arrangements (HRAs) can be helpful in managing your medical costs. HRAs allow a micro-business to reimburse employees for all out-of-pocket medical costs, including health insurance. If you are a self-employed business owner whose spouse works
part-time or full-time in your business, an HRA allows you the opportunity to fully deduct your medical expenses such as premium costs, dental expenses, vision expenses, co-pays, prescription drugs, and much more. This is particularly beneficial for sole proprietors who are unable to deduct health insurance costs as a business expense and must pay self-employment tax on their premiums.

Unlike HSAs, a qualifying high deductible plan is not required when you have an HRA.  Contributions to an HRA are 100 percent tax deductible and are not subject to federal, state or Social Security taxes.  In addition, many micro-business owners and self-employed individuals favor HRAs because there is no "pre-funding" requirement.  This means that the reimbursement of medical expenses only happens when those expenses are incurred.  You don't have to earmark money upfront for these accounts.

HRAs and the Self-Employed Micro-businesses tend to be a family affair. If you’re self-employed and your spouse works part-time or full-time for your business, Health Reimbursement Arrangements (HRAs) can assist you in fully deducting medical costs for you and your family. Step One: Make certain your spouse is a bona fide employee of the company. Your spouse must provide services to the company in exchange for compensation (i.e. salary and/or access to benefit plans) and must be treated as every other employee. Step Two: Your business must adopt a formal, written non-discriminatory plan. You can write the plan on your own as long as it is consistent with IRS guidelines (www.IRS.gov) or get assistance from numerous venders that offer prototypes of written HRA plans. HRA plan design options are limitless. As the business owner, you may permit all allowable medical expenses to be paid through the plan or restrict expenses. Step Three: Implement the plan. When your spouse incurs allowable medical expenses, he or she must submit to the business a request for reimbursement with a receipt/invoice indicating payment. The business pays your spouse via check for those expenses and you are able to fully deduct those costs from your company’s taxes. Only expenses incurred after the plan is adopted are deductible so be certain to have the plan in place. Tax professionals can be helpful in answering questions on HRAs and offer you assistance in setting up and managing one of these tax-preferred health accounts.

 

Health Savings Accounts (HSAs)

Health savings accounts (HSAs) are tax preferred accounts that can be set up in coordination with a qualifying high-deductible health plan (HDHP). An HSA is primarily funded by you and is fully portable. You own your HSA, regardless of your business structure or employment situation. HSAs are similar to individual retirement accounts in that your money is typically invested in mutual funds by your account administrator and your account accrues interest.

HSAs are typically administered by a financial institution, such as a bank, or an employer. There are contribution limits. Your annual HSA contribution cannot exceed the deductible of your high deductible health plan. For example, if you choose a plan with a $1,000 deductible, you may not deposit more than $1,000 in your HSA for that year.  If you want to save more than $1,000, you must choose a higher deductible plan. In 2009, your maximum contribution is capped at $3,000 a year for individuals and $5,950 for families.

If you're a micro-business through which your employees access a qualifying high-deductible health plan, as an additional benefit you can assist your employees in setting up an HSA and contribute annually to their accounts.  Some employers favor HSAs because they believe sole ownership in an HSA provides an added incentive to manage money and health care expenses wisely.

HSAs: Are They For You? You can put a significant amount of money into a health savings account ─ up to $ 3,000 a year for individuals and $5,950 for families in 2009. You can even make "catch-up" contributions if you’re 55 or older. HSAs tend to favor the young, healthy, and those with no children or whose children are older. These are the folks who can build up a substantial HSA account in a short time. The main purpose of an HSA is to conserve as much of your money as possible so that you can pre-fund your retirement medical expenses. The drawback is that not everyone is eligible for an HSA. In order to qualify, you must be covered by a high-deductible health insurance policy, either through your employer or one you purchase as an individual. (See Health Insurance Basics.) “High deductible” means your policy does not begin paying until you have accumulated at least $1,150 worth of out-of-pocket medical expenses. The family must be at least $2,300. Additionally, you’re ineligible for an HSA if you are also covered under another health plan that is not a high-deductible health plan, whether as an individual, spouse, or dependent.

 

How Do High-Deductible Health Plans Work?

Under an high-deductible health plan (HDHP), you generally choose your own deductible and you’re free to see any doctor you want without a referral. However, these plans also increase your share of the costs and risks. This is where HRAs and HSAs come in.

For example, under an HRA arrangement, let’s say your employer funds your health care account to cover the first $500 to $1,500 of your medical care. After that, you pay the next $1,000 to $3,000 of your medical costs out of your own pocket. Once your deductible is reached, your group health insurance plan kicks in and covers 60 to 70 percent of your medical costs if you see an out-of-network doctor, or 80 to 100 percent of your costs if you remain within the provider network. If you don't use the initial $500 to $1,500 given to you by your employer, you can roll over the remaining amount to use the following year, if allowed by your company.

HSAs work basically the same way, except  in addition to your employer, you can also make contributions to your own account, either through payroll deduction or a lump sum deposit up to the annual limit. The distributions from your HSA are restricted to the amount of funds that are actually available in your account. Under an HRA arrangement, if your employer agrees to fund your account with $1,000 annually, the entire amount is immediately available to you at the start of each plan year, similar to an FSA. However, if you are funding your own HSA through payroll deduction, you will have to “pay as you go” from your HSA, or use other personal funds while the money and interest in your HSA grows.

What about FSAs?

Offered by many employers since 1996, flexible spending accounts (FSAs) are the granddaddies of all health accounts. Allowed under Section 125 of the Internal Revenue Code, they let you to set aside money to pay for certain medical, dental, or even dependent care expenses. Your contributions are deducted from your paycheck before federal and state income taxes and Social Security taxes are withheld.

Though popular, FSAs have one inherent flaw. You must forfeit any unspent money at the end of the year. In addition, while FSAs can be fully integrated with HRAs, technically the IRS does not permit you to contribute to an HSA while covered by an FSA or HRA.

However, there are legal workarounds. The IRS has issued rulings which clarify under which conditions you are still permitted to access benefits from an FSA and HRA while remaining eligible to contribute to an HSA. They include:

• Limited-purpose FSAs and HRAs that restrict reimbursements to certain benefits such as vision, dental, or preventive care benefits.
• Suspended HRAs where you elect to forgo health reimbursements for the coverage period.
• Suspended HRAs where you elect to forgo health reimbursements for the coverage period.
• Suspended HRAs where you elect to forgo health reimbursements for the coverage period.

 

The main feature of these workarounds is that used either alone, or in combination, they prevent you from seeking multiple tax-favored reimbursements for the same expense. In other words, you can’t pay for a medical expense with your HSA, and then expect to be reimbursed through your employer-sponsored HRA. The chart below shows the main features of FSAs, HRAs, and HSAs for comparison purposes.

Account features	FSA	HRA	HSA
You own the account?	Yes.	Your company or employer owns it.	Yes
"Use-it-or-lose-it" by end of benefit year?	Yes.	No. Unused funds may be carried over from one benefit year to the next.	No. Unused funds may be carried over from one benefit year to the next.
You can access your account when you leave your job?	Yes.	Maybe — your company may opt to give you access, or may keep the money. Yes	Yes
Roll over unused funds when you leave your job?	No.	Yes, but only if your company allows you to do so and only for medical expenses.	Yes
You can contribute to the account?	Yes.	No. The company reimburses your medical costs to you.	Yes
Must be paired with a high-deductible health plan?	No.	No. An HRA can work in conjunction with any health insurance plan or no insurance plan at all	Yes. An HSA must be paired with a high-deductible health plan with minimum deductibles of $1,150 for individual coverage and $2,300 for family coverage. Out-of-pocket expenses for co-pays and insurance are capped at $5,800 annually for individuals and $11,600 for families.*
May be used in conjunction with other health care spending accounts?	Yes.	Yes.	No. You must use the funds in your HSA before you can be reimbursed for qualified medical expenses from your FSA.
You may use the money for expenses other than health care?	No.	No.	Yes. The funds in the account can be used for non-medical expenses, but they are then subject to ordinary tax, plus a 10 percent penalty if the participant is under age 65. (This penalty does not apply if the distribution occurs after the individual becomes disabled or dies.)
Tax consequences?	An FSA reduces your taxable income.	An HRA's reimbursements to you are tax-free.	An HSA's reimbursements to you are tax-free, within annual limits.
Contribution limits?	No. You decide how much you want deducted from your paycheck to fund your FSA.	No.	Yes. You and/or your employer are limited to $3,000 annually for individual plans and $5,950 for a family.*