Fiona Law examined a raft of traditional group insurance plans while looking to provide health and dental benefits for her staff at Calgary-based CompuTouch.
Her business, which uses technology to support interactive meetings and conferences, has just three full-time employees. She wanted something that was easy to set up and understand, a plan that would cover a wide range of medical expenses and offered the firm certainty of costs.
What she ended up choosing was not a traditional group insurance plan, but a health spending account (HSA).
"This was an alternative way of providing a benefit that was very straightforward and very transparent," she says. "It's a good compromise with a minimum of hassle."
HSAs have been around for many years and are now in place at thousands of small businesses in Canada.
But there are still many entrepreneurs out there who mistakenly think group health insurance is their only option to pay the medical bills that provincial medicare programs don’t cover.
What is an HSA?
A health spending account provides an attractive option for eligible small businesses to pay for all the medical expenses of employees and their families on a tax-free basis to the employee.
Eligible small business owners who provide HSAs can also deduct all their eligible medical and dental expenses from their gross business income, instead of making them a personal expense.
That makes HSAs an extremely cost-effective method of providing or supplementing health and dental benefits.
How do HSAs work?
Health spending accounts can be set up through third-party administrators/trustees or insurers that specialize in administering these plans.
Let's assume a small business owner has agreed to fund an HSA for his five arm's-length employees for up to $2,000 a year for each worker.
The employee (or a family member) visits a health practitioner and pays for an out-of-pocket medical expense (like prescription drugs, eyeglasses, or physiotherapy).
We'll assume they submit their receipts to a third-party administrator.
The administrator ensures the claim is legitimate and that the expense falls within the limit funded by the business. Once it's approved, the administrator sends a cheque to the claimant for the entire amount.
The claimant gets all their eligible medical expenses (plus any tax they may have paid) covered on a tax-free basis. And the business gets a 100 per cent tax deduction.
You can’t use a health spending account to cover your cosmetic surgery, though. Only medical expenses that qualify for the medical expense tax credit can be paid for through an HSA.
What does it cost?
Third-party administrators/trustees make their money by charging the business initial setup fees and sometimes annual fees, as well as transaction fees on claims that range from five to 15 per cent — 10 per cent is typical.
So a $1,000 claim would cost the company $1,000, plus the administration fee of perhaps $100, plus sales and premium taxes that vary from province to province. In Ontario, those taxes will add another $115 to the bill, making the total cost to the company $1,215 for a $1,000 claim.
That amount can in turn be entirely deducted by the business.
Depending on the nature of the business and the income bracket of the entrepreneur, the tax savings could be significant over having no plan in place.
Who is eligible?
For incorporated businesses, the owner and his employees are eligible to take part. Businesses with as few as one employee can be eligible under the rules. These plans cannot be for shareholders only, unless the shareholders are also bona fide employees earning a salary. The CRA has ruled that benefits limits must be reasonable.
When the business is unincorporated, the owner and his/her employee(s) are also eligible, but only if there is at least one arm's-length employee.
The CRA's view:
'It is the CRA’s long-standing view that a plan does not qualify as a PHSP where an administrator agrees to reimburse a sole proprietor and members of his or her household for actual medical and hospital expenses, and the administrator receives, as consideration, an amount equal to the reimbursed expenses plus an administrative fee. In such a case, the proprietor is simply paying for personal hospital and medical expenses for himself or herself and household members and the plan does not contain the necessary elements of insurance. Therefore, a HSA for a sole proprietor without any arms’-length employees would not be a plan in the nature of insurance.''
-- email to CBC.ca from Canada Revenue Agency
But when the business is an unincorporated sole proprietor with no employees, CRA rules do not permit an HSA. Self-employed people in this category who want a private health services plan must instead buy an insured plan through an insurance company.
Be aware that some administrators offer HSAs to unincorporated sole proprietors who have no arm's-length employees and say that their plans satisfy all the rules. Alarm bells should start ringing here. Merely adding a requirement to buy another insurance product, like critical illness insurance, is not enough.
“Adding a little bit of insurance to a non-qualifying plan does not make it a qualifying plan,” points out Auke Beerschoten, CEO of Assureflex Corp., a Strathroy, Ont.,-based company that acts as an administrator and trustee of health spending accounts.
One Alberta-based administrator stopped signing up new sole proprietor clients for a time after a CRA review found its plan did not meet the tax act requirements. It says its clients who are in this category have not had their claims rejected so it resumed offering them. But it acknowledged that there are risks in taking this position. So new clients in this category have been asked to sign a note that they “understand the attendant risk and possible loss of applicable tax deductions for health and dental expenses.”
What are the benefits of an HSA?
Many workers like the flexibility of HSAs. For instance, someone with an HSA that her small business has funded to the tune of $2,000 can decide herself how that money will be spent — dental bills for herself and registered massage therapy for her husband, or prescription drugs for her son and eyeglasses for her daughter.
Eligible medical costs are entirely paid for up to the funding limit. There are also none of the deductibles, co-payments or annual limits on particular kinds of services that some group health plans have.
For employers, HSAs provide cost certainty — they know up front how much their benefit costs will be. And if there are no claims from one employee, the business isn't out-of-pocket anything (other than the setup fee and whatever annual fee the administrator may charge).
With group plans, there's always someone who doesn't like what's covered and what isn't, or doesn't like the limits that may have been imposed. Some employees will want better drug coverage, while others might want better coverage for orthodontic work. With HSAs, each employee is able to choose how to spend their plan dollars.
Another benefit is that people with pre-existing health conditions may find it difficult to qualify for some group insurance plans. With HSAs, that's not an issue — all pre-existing conditions are covered. There is also no age limit.
One downside of HSAs is that they're designed to deal with more of the regular, routine types of medical expenses, such as teeth cleaning, prescription drugs and new eyeglasses — not a catastrophic medical issue.
For major (in other words, expensive) health events, traditional group health insurance plans tend to offer more coverage. With group plans, you can end up getting back a lot more than you paid in premiums.
Whether small business owners opt for traditional health plans or HSAs, it’s a good idea to seek professional advice. The tax consequences of running afoul of the rules can be painful.
An earlier version of this story suggested that all unincorporated sole proprietors are eligible for health spending accounts. As we have now made clear, unincorporated sole proprietors who have no arms-length employees are not eligible for HSAs. The earlier story also referred to HSAs as private health services plans (PHSPs) in the title and throughout the story. While many providers of HSAs refer to their plans as PHSPs, it is more accurate to refer to them as health spending accounts, which must conform to PHSP rules.Oct 25, 2013 2:59 PM ET