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How your business can control health care costs
Look at the financial statements of most companies, including your
own, and you’ll probably see that one of the largest expense items
is payroll and benefits. With health care costs continuing to
increase, your business may have a difficult time trying to balance
your employees’ needs with your bottom line. By considering
alternatives to traditional health insurance plans, you can cut
expenses and reap tax advantages.
Before you begin cutting some of the health care benefits you offer
workers, look for ways to reduce these expenses. For starters, shop
around. You may be able to reduce costs by buying from an insurance
carrier new in your area. Or if you are a small company, see whether
you can buy health insurance through a trade association or other
organization that caters to your industry. By becoming part of a
larger group, you might be able to obtain health insurance for your
staff at a more attractive rate.
Another option is to switch your plan type. Instead of a traditional
indemnity plan, offer an HMO or a PPO. These are typically more
limited, but also less expensive, than indemnity plans. By
switching, you could save from 10% to 50% per worker, depending on
plan types and coverage.
If you have a young and healthy work force, you may want to forgo
traditional insurance and self insure. Why? By paying health care
costs as they arise, you could spend less than you would on medical
insurance premiums. Also, you may be able to deduct these expenses
if bills are paid in a nondiscriminatory plan. To protect your
business in case health insurance claims exceed the set threshold,
buy “stop-loss” insurance.
Helping your employees improve their health or stay in shape also
can keep health care costs in check while reducing your tax bite.
Wellness programs such as smoking cessation and weight loss clinics
are deductible. Plus, workers will appreciate your interest in their
Consider health care options
Although your health insurance costs for employees are generally
100% deductible, the tax break may not be enough to help your bottom
line. So consider alternatives to traditional health insurance
plans, such as a cafeteria plan (otherwise known as a 125 plan).
By establishing one, you save taxes on the funds earmarked for
health care costs and your workers can both save taxes and choose
their health and dental coverage and other benefits from a menu of
options. They pay for only those they select, and you can
discontinue any that employees don’t value. Here are the two types
of cafeteria plans:
1. Premium-only plans (POPs). One way to cushion the financial
impact on your workers’ wallets is to offer a POP, which allows
employees to pay for insurance premiums with pretax dollars.
Employees save income tax and Social Security (FICA), and your
company reduces FICA and unemployment taxes (federal and usually
Let’s look at an example. Suppose you have 20 employees, each
contributing $1,500 in pretax premium contributions to a POP. Just
on FICA taxes alone, you’ll save $2,295 ($30,000 x .0765).
2. Flexible spending accounts (FSAs). These plans provide a tax-free
means of paying for out-of-pocket expenses such as health and dental
insurance deductibles and co-payments, optical care and medications
(including prescriptions and over-the-counter drugs).
With an FSA, employees contribute pretax dollars into an account.
Throughout the year, when they incur expenses, they can receive
reimbursements. But funds left unused by year end are lost to the
employee; the employer keeps the assets, which it may use to benefit
all workers, depending on plan regulations.
A new option for employers and workers is the Health Savings
Accounts that were created under the Medicare legislation in late
2003. For more on this vehicle, see “The ins and outs of Health
Savings Accounts” below.
Talk to employees
Health care expenses will likely continue to be a concern for at
least the next few years. But be careful that, in your quest to cut
your tax bill, you don’t alienate workers. Ask them which benefits
are attractive and those they can live without. Although your staff
probably won’t be pleased with a change in their health insurance
plan type, they will appreciate the opportunity to give feedback.
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Coverdell ESAs vs. 529 savings plans
The cost of a higher education continues to increase. In 2003-2004,
four-year public institutions raised tuition and fees to $4,694, on
average (a 14.1% increase over the previous year), while four-year
private institutions increased tuition and fees to $19,710 (a 6%
increase), according to the College Board.
But by contributing to an education savings program, you can provide
the necessary financial support so your children or grandchildren
can reach their goals and reduce your tax bite. Let’s take a look at
two popular plans: Coverdell Education Savings Accounts (ESAs) and
Section 529 savings plans.
Similarities and differences
Although there are many differences between ESAs and 529 plans, they
share the same purpose: to grow money for education expenses tax
free. You can make contributions to both plans on behalf of the same
individual each year. Here’s a closer look at the advantages and
disadvantages of ESAs and 529 plans in these areas:
Distributions. Under both plans, distributions are tax free for
federal purposes if used to pay qualified education expenses at any
accredited college or university, including most community colleges
and technical training schools. Two key differences: You also may
use ESA distributions for elementary and secondary education costs,
including academic tutoring, and the tax-free provision for 529
plans will expire in 2010 unless Congress extends it.
Contribution limits. Although there is an annual contribution limit
for ESAs ($2,000 per child), there is none for 529 plans. (Each
state and 529 plan sponsor sets its own limits.) Another
contribution drawback to ESAs is the income limit. In 2004, the
adjusted gross income phase-out range for making contributions is
$95,000 to $110,000 if you are single and $190,000 to $220,000 if
you are married filing jointly. However, a family member can still
contribute to an ESA benefiting your child. Meanwhile, there are no
income limits for contributing to 529 plans.
Control over investments. If you would like more control over how
your money is invested, then an ESA may be more appealing. Unlike
some 529 plans that require you to invest in a managed portfolio
based on your child’s age, you choose the investments that you’ll
hold in an ESA.
Federal and state income tax deductions. You cannot deduct
contributions for either plan for federal tax purposes. But if you
contribute to a 529 plan sponsored by your state, it may allow you
to deduct the contributions for state income tax purposes.
Although no states allow you to deduct ESA contributions, you may
benefit from other tax breaks. If you qualify, you can claim the
Hope or Lifetime Learning credit and still exclude ESA distributions
from your gross income. Just don’t use the ESA funds to pay the same
expenses for which you’re claiming the credit.
Estate planning. 529 plans offer a key estate planning benefit:
Contributions are considered gifts for gift tax purposes so you can
immediately remove the assets from your estate. Plus, you can use up
to five years’ worth of the annual gift tax exclusion at once. So,
you may give up to $55,000 ($110,000 if you and your spouse both
make gifts) without biting into your $1 million lifetime gift tax
exemption. But if you die before the end of the five-year period,
the remaining years’ gifts will be included in your estate.
Account transfers. 529 plan owners retain control over account
transfers. For instance, they can switch the beneficiary to certain
other family members, including themselves, for any reason. But
there may be gift tax consequences. You can do the same with an ESA,
but transfers are limited to fewer types of family members, who also
must be under age 30.
Meeting your goals
When it comes to saving for a child’s or grandchild’s education, the
process may be overwhelming. After all, college is much more
expensive than even a few years ago. Fortunately, there are a number
of ways you can help your loved ones get the education they deserve
and reduce your tax bill. And by starting to save today, you will
have more time for the assets to grow.
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New Health Savings Accounts offer pretax saving alternative
Want to use pretax money to pay medical expenses that aren’t covered
by insurance — and keep any unused dollars in a tax-deferred account
for later years? If you have a high-deductible health insurance
policy, last year Congress gave you just such a savings tool.
Stash money for future bills
Health Savings Accounts (HSAs) came into being as part of the
Medicare Prescription Drug, Improvement and Modernization Act of
2003. HSAs let people younger than 65 who have individual health
insurance deductibles of at least $1,000 contribute to tax-free
savings accounts. For family coverage, the deductible must be at
The new accounts offer more freedom than flexible spending accounts,
which must be set up by an employer and which require employees to
use funds during the year in which they save them. HSAs have neither
How much money can you put into an HSA? In 2004, you can contribute
the lesser of:
Your deductible amount, or
$2,600 if you have individual coverage or $5,150 for family
People between the ages of 55 and 65 can make larger “catch-up” HSA
contributions. But when you reach 65 and become Medicare-eligible,
you can no longer contribute to the account. Employers can fund HSAs
as long as they contribute an equal sum for all employees. If a
worker leaves the company, he or she takes the HSA along.
You can use your HSA to fund doctor visits, dental care, long-term
care and COBRA insurance premiums, prescription drugs, and more
expenses not covered by your health insurance. You can’t pay your
regular health insurance premiums out of the HSA, though.
Don’t use it and don’t lose it
One of the HSA’s best features is that, unlike flexible spending
accounts, it allows you to carry funds over from year to year if you
don’t use them in the year you contributed them — and the interest
isn’t federally taxable. But if you withdraw funds for non-medical
expenses before age 65 you’ll have to pay taxes and a penalty.
After you’re 65, you can make withdrawals without penalty even if
they’re not for medical expenses. If the withdrawals are for
non-medical expenses, you’ll owe taxes only.
HSAs are available to anybody who meets the age and health insurance
deductible requirements. You can be unemployed, self-employed or
employed but paying for your own health insurance. And unlike IRAs,
HSAs don’t become off limits to people whose earnings exceed a
certain dollar amount.
Some possible flies in the ointment: You have to find an insurance
carrier offering coverage you can use in conjunction with an HSA.
Not all do. And you must have the money to fund the HSA.
Start saving more
Who are the best HSA candidates? People who want protection from
huge medical costs but who are willing to take responsibility for
ordinary expenses and are disciplined about saving money. If you’re
in this category and are looking for a place besides your IRA or
401(k) to save pretax dollars, an HSA might be the answer.
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Setting up a low-hassle retirement plan
Employee retention and attracting high-quality staff are top
priorities for most business owners. Aside from salary and health
insurance, one of the best benefits to help create employee loyalty
is a retirement plan.
If you’ve been avoiding setting up a plan because you fear they’re
too complex and expensive to maintain, you’re in for a pleasant
surprise. Three kinds of IRA-based retirement plans, with tax
benefits for both employees and employers, often are simpler to set
up and administer than the better-known 401(k) plan.
Choosing a plan
Small to midsize businesses often lack the ability to set up complex
employee retirement plans. But the payroll-deduction IRA, Simplified
Employee Pension (SEP) plan and Savings Incentive Match Plan for
Employees (SIMPLE) are all fairly easy to put in place and
administer. All the plans have three features in common:
1. Because they’re based on IRA rules, funds in the accounts grow
tax-deferred (for plans
based on Roth IRAs, contributions are post-tax and earnings won’t
get taxed), as long
as they’re maintained and distributed according to IRS rules.
2. Contributions aren’t taxed as income until funds are distributed.
(Roth IRA contributions
are nondeductible and earnings are never taxed.) Typically, funds
get taxed after
retirement when the account owner is in a lower tax bracket — unless
he or she takes
3. Contributions are immediately 100% vested.
Companies of any size can establish payroll-deduction IRA or SEP
plans, but they must have 100 or fewer employees to be eligible for
the SIMPLE. The employer can deduct its contributions to employee
accounts under the SEP plan and the SIMPLE (except those to Roth
Comparing the options
Each plan works a little differently. Here’s the rundown:
Payroll-deduction IRA. Many employees who are eligible to contribute
to an IRA wait until year end to do so — only to discover they
haven’t saved the money. Payroll deductions let employees plan ahead
and add a small amount each pay period. Although the employer can’t
contribute, offering the plan gives workers a convenient way to save
and makes it more likely they’ll do so.
Each employee establishes his or her own IRA through a financial
institution and authorizes the company to make a payroll deduction
directly to the plan. Employees (not the employer) can deduct
qualifying IRA contributions from their gross incomes.
Payroll-deduction IRAs, just like a regular IRA set up separately by
an individual, have a lower maximum annual contribution than SIMPLEs
or SEP plans. The maximum for 2004 is $3,000 (double that for
couples), or $3,500 for individuals age 50 and over. In 2005 and
again in 2008, the maximum contribution will increase by $1,000.
SEP plan. You can establish a SEP plan through almost any financial
institution and pay low administrative costs. The employer sets up
an account for each eligible employee (including the owners). Then
it — but not the employees — may contribute to the accounts. You
don’t have to add money every year, but when you do, you must
contribute a uniform percentage of pay for each worker.
The maximum contribution (and deduction) for 2004 is 25% of pay or
$41,000, whichever is less. That amount is indexed for inflation
SIMPLE. This plan lets employees contribute up to $9,000 in 2004 and
$10,000 in 2005. Participants age 50 or over can contribute an
The employer must also participate in one of two ways. For workers
who choose to contribute, the employer can match contributions up to
3% of each employee’s pay. Or the employer can contribute 2% of each
worker’s pay, even for those who choose not to make their own
Making the effort
Employee loyalty has sagged in recent decades, and the leading edge
of the huge baby-boom generation will soon begin retiring. At the
same time, the number of 25- to 34-year-old workers will decrease,
according to the Bureau of Labor Statistics. Employers will have to
work harder to attract and retain good employees from a shrinking
Offering a retirement plan can only help your chances of attracting
and retaining the kind of employees you want. So don’t pass up this
key benefit just because you’re reluctant to take on the
administrative challenges — it’s worth the effort.
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