If a medical expense reimbursement plan isn’t appropriate, either because you don’t have a spouse to hire, or you have non-family employees you would have to cover, consider establishing a Health Savings Account. These arrangements combine a high-deductible health plan with a tax-free savings account to cover unreimbursed costs.
To qualify, you’ll need to be covered by a “high deductible health plan.” This means the deductible is at least $1,250 for single coverage or $2,500 for family coverage. Neither you nor your spouse can be covered by a “non-high deductible health plan” or Medicare. The plan can’t cover any expense, other than certain preventive care benefits, until you satisfy the annual deductible. You’re not eligible if you’re covered by a separate plan or rider offering prescription drug benefits before the minimum annual deductible is satisfied.
Once you’ve established your eligibility, you can open a deductible “health savings account” to cover out-of-pocket expenses not covered by your insurance. For 2013, you can contribute up to $3,250 if you have individual coverage or $6,450 if you have family coverage. (If you’re 55 or older, you can save an extra $1,000 per year.)
HSAs are easy to open. Most banks, brokerage firms, and insurance companies offer them. Many times you can even get a debit card to charge expenses directly to the account.
Once you’re up and running, you can use your account for most kinds of health insurance, including COBRA continuation and long-term care (but not “Medigap” coverage). You can also use it for most of the same expenses as a MERP – copays, deductibles, prescriptions, and other out-of-pocket costs.
Withdrawals are tax-free so long as you use them for “qualified medical costs.” Withdrawals not used for qualified medical costs are subject to regular income tax plus a 20% penalty.
After your death, your account passes to your specified beneficiary. If your beneficiary is your spouse, they can treat it as their own HSA. If not, your beneficiary will pay ordinary tax on the account proceeds (but not the 20% penalty).
The Health Savings Account isn’t quite as powerful or flexible as the MERP. You’ve got specific dollar limits on what you can contribute to the account, which might not match your out-of- pocket costs. And there’s no self-employment tax advantage as there is with a MERP. But Health Savings Accounts can still help cut your overall health-care costs by giving you bigger tax deductions.
Flexible Spending Accounts
Flexible spending accounts (“FSAs”) let you set aside pre-tax dollars for a variety of nontaxable fringe benefits, including health and disability insurance and medical expense reimbursement. (Some employers also offer FSAs for daycare costs, but we’ll skip those in the interest of sticking to Obamacare.) Plan contributions avoid federal income and FICA tax.
The new rules let you contribute up to $2,500 per year to your account. Before Obamacare, there were no contribution limits at all. Many observers have called the new $2,500 limit a tax in disguise, especially for older workers with expensive prescriptions who tend to contribute more to their accounts.
Once the money is in the account, you can use it for most medical expenses. However, nonprescription drugs and supplies, long-term care coverage associated and expenses are not eligible FSA expenses.
Your employer deducts plan contributions from your paycheck and deposits them into your account until you claim your reimbursements.
When you enroll, you have to choose how much to contribute each pay period. You generally can’t change your contribution amount in the middle of the plan year unless there’s a change in your “family status.” Eligible changes include marriage or divorce; birth, adoption, or death of a child; spousal employment; change in a dependent’s student status; and the like.
You can claim your full year’s reimbursement as soon as you incur qualifying expenses, whether you’ve fully funded your account for that amount or not.
Historically, FSA rules have required you to use your account balance by the end of the year or forfeit it. However, many employers’ plans have taken advantage of a subsequent ruling that lets them amend their plans to provide a 2½ month grace period immediately following the end of the year.
Resources: There are also several related stories written by Intuit’s Mike D’Avolio about the Affordable Care Act. In addition to the stories below, be sure to review Intuit’s own webpage on the Affordable Care Act.
- Understand the Tax Effects of the Affordable Care Act
- Understanding the Affordable Care Act
- Affordable Care Act’s Impact on Individuals and Small Businesses
- What Does the Individual Mandate of the Affordable Care Act Really Mean?
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