If you have or are thinking of starting a business, please read this article.
HRA Market Continues to Explode
By Gerard DeMare, United Financial Services, Highlands Ranch, Colo.
In April of 2003, I wrote about the importance of health reimbursement arrangements (HRAs) being a major part of your portfolio. Over the years, I’ve tried to keep you updated as the markets slowly moved away from health savings accounts (HSAs) and our clients aggressively took advantage of the overwhelming benefits of the HRA. This trend has continued and now is at its peak point. Because of our current economic difficulties, business owners simply do not have the money to fund HSAs with up-front cash. This makes the HRA a much more attractive avenue — to purchase their health and life insurance at lower premiums and receive greater tax relief than they are currently getting.
The HSA
For those of you who aren’t completely familiar with the HSA, here is a brief summary of what they are and how they work. In 2003, President Bush signed into law the HSA, allowing employees to own tax-favored savings accounts that can be used to pay for qualified medical expenses. Qualifications include participation in a high-deductible plan and attachment to a tax-favored trust or a custodial account with a bank or financial institution. These requirements must be met before an employer can establish an HSA for his or her employees. After the HSA is established, it may be funded by the employer or the employee with caps of $2,850 for individuals and $5,650 for families. These contributions are tax deductible to whoever is funding the account.
The HRA
Health reimbursement arrangements originally were derived from Section 105 of the Internal Revenue Code. It was enacted in 1954 in an attempt to encourage small businesses to provide benefits to their employees. HRAs need not be funded up front, and this makes them very attractive. The employer simply establishes a set dollar amount for each employee that will allow them to be reimbursed for any qualified medical expenses and insurance premiums. While there are certain eligibility requirements, they are not as restrictive as the deductible requirements of an HSA.
How do the two plans truly differ? The biggest difference is in the ownership. The HSA is solely owned by the employee who is participating, while the HRA is owned by the employer. Funds can be dispensed from the HSA for both qualified and non-qualified medical expenses, but non-qualified withdrawals will result in a 10% excise tax penalty. With the HRA, the employer is not required to reimburse until after the qualifying medical expense has been incurred. Because the employer is the sole owner of the plan, he or she has greater leeway in how the HRA funds will be used. Annual limits can be set with carryover and carry forward amounts, and the employer can adjust these amounts annually when re-electing the benefit package. This freedom also allows the employer to deduct 100% of any qualified medical expenses and insurance premiums paid.
Most individuals choose to go to a third party administrator to establish their HRA; it is the safest choice because the process is so technical. We have seen fees that range from $99 to $500 based on the size of the company. By the way, that fee is 100% tax deductible!
We receive several letters weekly from brokers who want to learn more about HRAs and how they can get involved. I recently received a letter from a business coach with whom we work who is now recommending that all of her qualified clients take advantage of the benefits of the HRA. The letter said:
“As a business coach who works with small business owners, one of my first tasks is to review all of the benefit programs my client has to verify possible tax disadvantages and opportunities he or she might have for future tax deductions. One of the programs I focus on particularly is health benefits. Most people think of group insurance as a costly item in a small business, one that is difficult to afford. I usually suggest that they talk to a financial planner about generating a health reimbursement arrangement. I believe the HRA is great because it allows a deduction on a pre-tax basis, greatly lowering the employer’s liability for gross wages. I like the fact that contributions are not included in the employee’s income, and that you don’t have to pay federal income taxes or employment taxes on amounts the employer contributes to the HRA. So if you are a business owner, you can contribute to your own HRA and deduct the full amount as a business expense.
“I also like the fact that all amounts that were not used can be rolled over into following years. I find it very convenient that there is no limit to amounts that can be contributed, making it a much stronger tool from a tax point of view than the HSA. I always advise my clients to speak with their financial advisor and business consultants to ensure that an HRA is the best resource for them and that they qualify for its benefits. But in general, this plan is a great way for the small business owner to compete with the larger corporations’ benefit packages and it is of great benefit to not only the employer, but also the employee. Thanks for sharing your knowledge, and I look forward to educating my clients about the real tax advantages they could be taking advantage of.”
One thing I have enjoyed the most about the HRA is that I can truly build a benefit package for my clients, not just sell them health and life insurance. I use this example when speaking with a client who qualifies:
A sole proprietor pays $5,000 annually for his family health insurance premium, and an additional $2,000 for non-insured medical expenses, such as deductibles, co-pays, life insurance premiums, vision care, dental care, and prescriptions. His health insurance premiums are 100% deductible, giving him a tax relief of $750, based on a 15% tax bracket ($5,000 deduction x 15% federal tax rate = $750).
He now is enrolled in an HRA with the same scenario — 15% federal tax, 5% state tax, and 15.3% self employment tax. He would have received $2,471 in tax relief:
$5,000 + $2,000 = $7,000 (now an official business deduction).
$7,000 x 35.3% (combined tax) = $2,471 total savings.
Your client can now use these extra funds to improve their benefit package, making the employer happy, the employee happy, and earning you, as the broker, an additional commission! We recommend the client use these additional funds that would have gone to the IRS to fund additional IRAs, thus accelerating the rate of achieving their retirement goals.
There are more than 150 items that can be deducted with an HRA that your client cannot currently deduct now. For example, acupuncture, back supports, chiropractors, contact lenses, cosmetic surgery, dental, dermatologist, prescription drugs, eyeglasses, gynecological exams, insulin, non-prescription medication, prenatal care, psychiatric care, and even smoking and weight loss programs can be deducted. The list goes on and on. Your clients are spending thousands of dollars on these types of products and services every year, and you have the ability to save them a tremendous amount of expense.
I hope that this information has been informative to you and will help you on your path to making the HRA part of your portfolio. We would love to assist you in any way possible if you have any questions. I strongly encourage you to educate yourself on the inner workings of the HRA and be informed for the benefit of your clients. I can guarantee you that you will see an increase in the success for your practice by using this administrative process.
Gerard DeMare is the president and chief executive officer, working with vice president Dayna Pagard, for United Financial Services. Mr. DeMare has more than 20 years of experience in the design and marketing of insurance, financial, and advanced tax research products. He is currently working with top-rated insurance companies to improve how the industry functions and create more success for agencies across the country.
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