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.

Trim costs
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 well-being.

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 state).

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 least $2,000.

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 requirement.

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 coverage.
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
early distributions.

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 IRAs).

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 yearly.

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 additional $1,500.

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 contributions.

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 labor pool.

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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