If you are a typical employee working for a U.S. company, chances are it’s time for you to renew your annual employee benefits for 2006. You’re faced with a “cafeteria” of choices so you can customize benefits to your taste. Flexible spending accounts, healthcare savings accounts and premium-only plans are just a sample of what’s on the menu. But do you know what to put on your plate?
If you’re like many workers, you usually decide to forego those options because they’re either too complicated or too scary for you to consider. According to the Employee Benefit Research Institute, only 8 percent of full-time workers opt for a cafeteria plan or, referring to its IRS code section, 125 plan. But that decision will no longer fly in the future as more companies pull back from covering the majority of their employees’ healthcare bills.
“As healthcare costs and workers comp rates continue to rise, 125 plans will become more popular with employers,” said Leonard Sanicola, senior practice leader at WorldatWork, a nonprofit association for compensation and benefits education. “2006 will be the year when you see large employers offering these plans in conjunction with traditional plans, with the goal down the road of making 125 plans the only ones offered so that employees become more accountable for their expenses.”
But these plans can benefit you as well as your employer, with their biggest advantage to you being the reduction of your tax bill by hundreds of dollars.
“They’re the most cost-effective benefits to have,” said Dana Sippel, a certified financial planner and certified public accountant in McLean, VA. “You can set aside money on a pretax basis, so it’s not only free of Federal and state taxes, but Social Security and Medicare taxes too.”
Here’s a rundown of the cafeteria plans most offered by companies currently.
Premium-only plans
Premium only plans, or POP, (also known as premium conversions), are the most basic arrangements, allowing you to pay for your contributions to health and insurance premiums in pre-tax money through payroll deductions. You reap the “discount” by not paying taxes. For example, if you’re in the 30 percent tax bracket and you put away $100 monthly in a POP, essentially you’re only paying $70 in premiums since they’re not being taxed.
Sanicola said these plans are a win-win for employees, but he cautions those close to retirement from using a POP. “If you’re a year or two from retirement and paying a lot for healthcare, switching to a POP and its pre-tax premiums could impact your Social Security payments because they’ll reduce your income that the payments are based on.”
Dependent-care flexible spending accounts
Flexible spending accounts (FSAs) lets you put pre-tax dollars through regular payroll deductions into an account for healthcare or dependent care, and you can tap that account to pay for any qualified, unreimbursed expenses you have during the calendar year.
Like POPs, the upside is you get a “discount” on the money you would have paid otherwise in income taxes. So if you’re in the 25 percent tax bracket and put $3,000 in an FSA, you theoretically will be saving $750 in medical bills. The downside: You must budget accordingly and do it a year in advance, putting just enough money in your account since a “use it or lose it” clause means any money you don’t spend by year’s end is lost. Even worse, you don’t get it back — your employer does.
With an FSA for dependent care, you’re allowed to bank up to $5,000 per year ($2,500 if you’re married and filing single) to pay for care given to children, elderly parents and handicapped dependents.
The big caveat with a dependent-care account is that using it makes you ineligible for using the childcare credit ($3,000 per child) on your tax return. Therefore, you should look at which method gives your family the most bang for its buck, usually depending on the number of children you have and your income.
Sippel believes the FSA is the better bet for most families. “Say you pay 38 percent in Federal and tax savings, you can get $1,900 in savings through a dependent-care FSA. Even at the higher $6,000 for two children, the tax credit only earns $1,200 in savings. If you have children, you definitely should be opting for the FSA.”
Employees who take care of their parents can also use this FSA, but the rules about what qualifies as dependent-care are trickier. Sippel says it applies to people who may more than 50 percent of their dependents’ support.
Healthcare flexible spending accounts
These accounts are similar to dependent-care FSAs except that your company sets the limit you’re allowed to bank each year. Most companies’ limits range between $1,500 and $3,000. You can open an healthcare FSA even if you’re not enrolled in your company’s medical plan.
The account covers qualified, unreimbursed medical and dental expenses. The IRS recently approved reimbursements for over-the-counter drugs like Claritin and Advil. Big-ticket items such as Lasix and braces are covered, but cosmetic procedures like teeth whitening and liposuction are not.
Since many people are scared off by the “use it or lose it” clause, Trent D. Bryson, president of Bryson Financial Group, an employee-benefits consulting company in Long Beach, CA, says the key is to predict just how much money you’ll need for healthcare — one year in advance.
“Look at what you spent last year on medical expenses, like twice-yearly teeth cleanings, appointment copays, monthly birth control, and think about what you’re spending on an annual basis. I generally recommend taking 10 to 15 percent off that number to be conservative, and then dividing that figure by 26 bi-weekly paychecks.”
“Also think about any big medical events you’re planning for in the year to come, like a surgery or the birth of a child, and determine the details of how much that will cost you.”
There’s no plan yet by Congress to allow FSA money to roll over from year to year, but the IRS recently did allow companies to permit a grace period so employees can make claims against their accounts until the first quarter of the following year. So for 2006, you have until March 31 to file claims for medical reimbursements, or still even undergo medical procedures and get reimbursed for 2005. However, this is left to companies’ discretion, so you should check your employer’s plan to see if they offer this extension.
Health savings accounts
Introduced just this year, health savings accounts (HSAs) are another tax shelter that are giving healthcare FSAs a run for their money. You can use this IRA-like account to cover out-of-pocket medical costs with an annual limit of $2,650 for an individual, $5,250 for a couple. (A catch-up provision allows those over age 55 to contribute an additional $600 in the 2005 tax year.) And the HSA even outshines the IRA because contributions, investment growth and withdrawals for health-related expenses are all free from taxation.
The catch: Since HSAs are designed to pay for health expenses until insurance benefits kick in, they are linked to high-deductible health insurance plans through your employers (at least a $1,000 deductible for an individual and $2,000 for a family). Also, HSAs currently don’t cover reimbursement of routine healthcare items (i.e., over-the-counter medication) like FSAs do.
“An HSA is perfect for someone who’s very healthy without a lot of out-of-pocket expenses,” said Sippel. Families with young children probably will benefit more from traditional managed-care options such as preferred provider organizations. You can have both a HSA and a healthcare FSA, but IRS rules stipulate that you have to use the former first to pay for healthcare expenses, and only then the latter when the HSA has been depleted.