As healthcare costs seem to spiral out of control, a change in IRS regulations should help lessen the dent caused by out of pocket expenses for some employees with Flexible Spending Accounts (FSA), also referred to as cafeteria plans or Section 125 plans. With an FSA, employees can set aside money before taxes are taken out to pay for health insurance premiums, unreimbursed health expenses and dependent care expenses. Until this year, expenses for most non-prescription drugs could not be paid for through the unreimbursed health expense portion of the FSA. As a result of IRS Revenue Rulings 2003‑102 and 2003‑108, effective January 1, 2004 many over-the-counter non-prescription drugs will now qualify for reimbursement.
Among the newly eligible medications are allergy medicines, pain relievers, antacids, cold remedies and flu remedies. All forms of these medications (e.g., tablet, liquid, capsule, drops) are eligible and include generic and store or name brands. Also included are drugs which were recently made available over-the-counter and no longer require a prescription, such as Claritin and Prilosec. Expenses must be for treatment of an existing disease or to prevent a disease that is likely to occur if the medication is not taken. The quantity purchased must be reasonably able to be consumed during the current plan year.
Items such as vitamins, herbal and dietary supplements, cosmetic treatments and products that are for maintaining general good health are not included in the new rulings and still remain ineligible for reimbursement. The rulings also do not apply to medical supplies such as tape, gauze and bandages.
Proper expense substantiation is still required, such as a cash register receipt. The receipt must show the date the expense was incurred and must clearly identify the name of the purchased item. Be sure employees know to include these new eligible expenses when requesting reimbursement from your Flexible Spending Account.
Health Savings Accounts
Also on the subject of cafeteria plans, new for 2004 are Health Savings Accounts (HSA). These replace what were called Archer Medical Savings Accounts (MSA).
The Basics
The way HSAs work is that groups with high deductible health insurance plans can put money into the HSA pre-tax for expenses not covered by the health insurance. A high deductible insurance plan is defined one having at least a $1,000 annual deductible for individuals or $2,000 for families and a $5,000 cap for individuals for out of pocket expenses or a $10,000 cap for families. Contributions to the HSA are limited to the lesser of the amount of the deductible or $2,600 for an individual plan and $5,150 for a family plan. A HSA is similar to an unreimbursed health expense account in a Section 125 plan in that both are subject to the same restrictions on the types of expenses that may be reimbursed by the plan. However, they differ in that contributions made to an HSA can be carried over from year to year, whereas with an unreimbursed health expense account, money not used by the end of the year is forfeited.
The Pros
Health Savings Accounts will potentially be a great benefit for employees. They can set aside money pre-tax (employer contributions are also allowed) for some health care expenses that would have come out of pocket after tax.
The money in the account can be carried over from year to year if someone overestimates the amount of expenses he or she will have in a given year or wants to save up money for an expense or procedure that would have cost more than he or she could have set aside in one year.
Health Savings Accounts can be offered as part of a cafeteria plan, so employers do not have to offer two options; they can roll it all into one.
Individuals can use debit, credit or stored value cards that deduct money directly from the HSA. This greatly simplifies the process for the individual to pay for qualifying expenses.
The Cons
To a certain degree, this is uncharted water. It seems that only a few benefits companies have started offering these because the IRS has not yet issued final regulations, reporting procedures or compliance forms. These are supposed to be released in the first half of this year, but until then some companies are taking a “wait and see” approach.
One reason for the cautious approach is that the MSAs that the HSAs replace were not very successful products. When the regulations were finalized, it turned out that only a few people qualified for the MSAs, so the benefits companies did not think it was worth it to develop a product that had only limited applicability. So far, the HSAs seem to have a broader application and may not have the same problem.
Participation may also be limited if people are not willing to trade off lower insurance premiums for the reduced benefits they receive from the health insurance plan as a result.
Employers may not be interested in offering HSAs as a benefit because they receive very little from offering the plan. With Section 125 plans, the employer saves some from not having to pay employment taxes on the pre-tax contributions, but also unused money reverts back to the employer at the end of the plan year. With HSAs, an employer only gets the tax savings, because any money that goes into the HSA stays with the employee. Therefore, employers must understand that most of the benefit they will receive will be intangible in the form of increased employee satisfaction with the company’s benefits plan.
Conclusion
There is not yet a lot of information available on HSAs since the plans are new and what is available is still very speculative. Nevertheless, the plans may be worth looking into as a low cost added benefit for employees. You can get more information from companies offering these types of plans or by reading IRS Notice 2004-2, which is available on the IRS website at www.irs.gov.
