An HCSA is very much like a bank account: the employee can use the funds in the account to pay for eligible health and dental expenses that may not be covered under the traditional health or dental plan. Allowable expenses under an HCSA are wide-ranging and include items such as deductibles and co-payments, as well as expenses for prescription drugs, vision care, dental work, devices and supplies, medical practitioners and other medical services. To be eligible for reimbursement, expenses must not be covered in full by a provincial healthcare plan or any other private healthcare plan. While traditional benefits programs restrict coverage to just the employee, spouse and dependent children, Canada Revenue Agency(CRA) guidelines enable HCSAs to reimburse eligible expenses incurred by any family members, as long as they are financially dependent on the employee.
In order to receive favourable tax treatment, an HCSA must qualify as a Private Health Services Plan(PHSP)as defined by subsection 248(1)of the CRA Act and Interpretation Bulletin IT-339R (1998). This generally means that the plan may only cover medical expenses as defined in subsection 118.2(2)of the Act and must involve the transfer of a “reasonable degree of risk” to the insurer or employer.
Provided that an HCSA meets the conditions required by the CRA, it is treated the same way as any other group health insurance plan: the employer contribution to the HCSA is not taxable income to the employee, and there is no tax liability for the benefits received. The situation is different in Quebec, however, where the payments made under an HCSA are subject to Quebec income taxes. Employers should confirm the current tax position before implementing an HCSA, since the CRA’s position may change over time.
Structure of HCSAs
When considering an HCSA, the employer must first decide what type of account to establish. An HCSA can cover health expenses or dental expenses or, more commonly, it can cover both types of expenses. The employer can tailor the plan to the desired dollar level using a flat amount or a percentage of earnings and can allocate amounts on a monthly, quarterly or annual basis. The employer must be responsible for funding the plan—employees are not permitted to make contributions.
The employer must also decide how to handle contributions from year to year. In order for an HCSA to satisfy CRA requirements and retain its non-taxable status, it must contain an element of risk. For this reason, unused balances or unclaimed expenses may be carried forward for one year only.
There are three options available to the employer when it comes to handling contributions.
1. No carry forward: Unused credits allocated at the beginning of the year are forfeited at the end of that year.
2. Rolling contribution: Contributions made in one benefit year can be rolled over to the next benefit year if not used in full; however, any remaining values after 24 months are forfeited. For example, if an employee is credited with a dollar amount on Jan. 1, 2007, and has not used the credits by Dec. 31, 2008, any unused portion of the 2007 allocation will be forfeited.
3. Roll over unclaimed expenses: Unclaimed expenses from the previous year are carried forward into the next calendar year. Again, the roll-forward provision is only valid for 24 months.
Benefits of HCSAs
HCSAs can be beneficial for employers and employees alike. One significant advantage is that they allow reimbursement of eligible health-related expenses in pre-tax dollars. Since these dollars are directed to an employee account before income tax is deducted, compensation provided through an HCSA goes much farther than if employees themselves paid for comparable health-related expenses. The cost of providing the HCSA is a tax-deductible expense for the employer, and the employee receives the benefit on a tax-free basis.
Checklist for employers To determine if HCSA s are the right choice for your organization, ask yourself the following key questions: 1. Is the overall objective to enhance employee benefits or to control costs? 2. Do your employees expect and want their employer to take care of their healthcare needs, or are they looking for more flexibility and control? 3. Where will the funds for the HCSA come from? How much is available? 4. How will you budget for HCSA funds, both for the current year and for carry-forward balances? 5. What will it cost to administer the HCSA ? How are claims submitted? What type of reporting can you expect from the HCSA provider? 6. How will you communicate the HCSA to your employees? |
Over time, HCSAs offer employers an effective means of controlling benefits costs. If introduced in conjunction with reductions in the level of coverage provided by the traditional extended health and dental plans, an HCSA can provide greater flexibility to the employee with little or no increase in the actual healthcare dollars spent by the employer. Because employers determine the contribution amounts that are credited to the HCSA each year, future healthcare costs are driven less by external health and dental inflation and more by internal budget considerations. Essentially, the employer defines the contribution rather than the benefit, which makes it easier to manage the cost of providing healthcare to employees.
An HCSA can also help educate employees regarding the value of their benefits, since most individuals can better understand the significance of a fixed dollar amount than a contractual promise to pay. The choice offered in an HCSA may result in increased employee awareness of benefits and a stronger appreciation of the benefits provided by the employer.
From an employee’s perspective, the main advantage is greater choice and flexibility in how their benefits dollars are spent. Employees often cite choice—or the lack thereof—as their biggest complaint with traditional benefits programs. An HCSA gives employees true flexibility in deciding which healthcare services they need. The only requirement is that expenses submitted through the HCSA must qualify as eligible expenses under the CRA guidelines(for a complete list, visit the CRA website).
Challenges and Considerations
One common challenge that many employers encounter when implementing an HCSA is effective communication with employees. When your employees have a greater degree of choice, it’s critical that you communicate the program clearly and effectively so that they can make informed decisions.
Furthermore, if you’re introducing an HCSA in conjunction with decreased benefits in the health or dental programs already in place, some employees could be net losers of benefits coverage, and you need to be ready to deal with this situation. To ensure that you’re well prepared, you may want to consider engaging an external consultant to help you review your benefits plan, design the HCSA, provide budget projections and develop a communication and implementation plan.
When properly designed and implemented, HCSAs can be an effective benefits solution for employees and employers alike. Careful consideration of the HCSA plan design, combined with open and honest communication with employees, will help ensure that your HCSA initiative is a success.
Andrea Rothe and Liz Lirette are both senior consultants with Morneau Sobeco. arothe@morneausobeco.com; llirette@morneausobeco.com
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