Employers—especially owners of growing businesses—may want to consider using a profit-sharing approach to funding employees' health savings accounts (HSAs) tied to a high-deductible health plan (HDHP). Under this strategy, the company contributes to their employees' HSAs (used to fund first-dollar benefits prior to reaching the deductible) when the company can afford it.
As part of a profit-sharing model, employer-provided HSA contributions can replace cash bonuses as incentive compensation tied to performance, just as many employers now make extra 401(k) contributions to employees in lieu of cash bonuses.
Before discussing the advantages of an HSA profit-sharing model, it may be helpful to briefly review some HSA basics:
• Deductibles. To participate in an HSA, an employee must be covered by a qualified HDHP. For self-coverage, the minimum deductible is $1,000 with a maximum out-of-pocket of $5,000 (including the deductible). For family coverage, the minimum deductible is $2,000 with a maximum out-of-pocket of $10,000. Beginning in 2005, the minimums and maximums are indexed to the cost of living rounded to the nearest $50.
• Contributions. The employer or employee (and members of the employee's family) may contribute to an HSA. For 2005, the maximum that may be contributed for single coverage is the lesser of the deductible under the HDHP and $2,650. For family coverage, it's the lesser of the deductible and $5,250. Going forward, maximum contributions will be indexed to the cost of living, rounded to the nearest $50. For employees between ages 55 and 65, an additional $600 in HSA contributions can be made for 2005. (The catch-up amount will increase by $100 every year until it reaches $1,000 in 2009.)
The Advantages of HSA "Profit Sharing"
A profit-sharing model for contributing to employees' HSAs provides several advantages over cash bonuses.
� Variable costs. For the employer, the HSA becomes a variable cost, increasing when the firm can afford it and decreasing when it cannot. In years when the firm cannot fund the HSA, the employees can elect to fund it themselves.
� Tax savings. For cash bonuses, federal taxes are withheld at the supplemental tax rate, many times taxing 40 percent or more of the bonus when combined with other taxes. Employees are often disappointed when they see how small their check actually is.
Employer contributions to HSAs, on the other hand, are tax-deductible in the year contributed and are not subject to withholding for income taxes. Nor is the employer contribution subject to the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA) or the Railroad Retirement Act withholding requirements. As a result, the actual net bonus is more valuable as an HSA contribution than as cash.
ABC Manufacturing decides that it wants to give a $1,000 bonus to its employees.
Since employees are covered under a qualified high-deductible health plan, they have the option to fund an HSA or give cash compensation. If ABC elects to pay the bonus in cash, it is subject to FICA and FUTA, costing the company approximately $100. In addition, the employee is taxed at the supplemental tax rate and must pay their share of FICA. As a result, they will receive approximately $500.
Had the employer paid the bonus into the HSA, they would not have had to pay the FICA or FUTA and the employee would have received the full $1,000, a significant difference to the employee.
• Withdrawals. Employees who need extra cash can make a nonqualified withdrawal from their HSA. Nonqualified withdrawals, however, are subject to the individual's normal tax rate plus a penalty of 10 percent if the member is under age 65. If individuals are over age 65, they only pay their normal tax rate.
• Timing flexibility. Cash bonuses tend to be paid in a lump sum on an annual or quarterly basis. HSA contributions, however, can be made on a monthly basis, enhancing employee retention and spreading the cost over the year. If the employer contribution to the HSA is made monthly, the total expense will be less for any employee that leaves employment prior to the end of the year and should serve as an aid to retain employees.
• Aligning employer and employee goals. A profit-sharing model closely aligns the goals of the employees with the goals of the firm. There is a direct and visible reward to the employee for enhancing organizational performance.
Taking an Evolutionary Approach
There are challenges to implementing this approach. As a result, many employers will use an evolutionary rather than revolutionary strategy. This will give employers time to embrace the consumer-directed health care model and to focus on how they can help employees improve their health.
Initially, most employers are going to add HSAs tied to an HDHP as an option, increasing participation as success stories emerge. It may take several years before a majority of employees are in this type of plan. There will undoubtedly still be members in the traditional health plan that do not want to change. The employer can help their employees� transition to the new design by clearly communicating well in advance the strategy and timing for change.
As part of this strategy, employers should use a profit-sharing formula that is fair and properly rewards good performance. Use of arbitrary goals and measurements will harm the credibility of the program. Communication of results should not be a once-a-year discussion; rather, there should be routine communication throughout the year, engaging employees to achieve positive results.
This will be a challenge for privately owned companies that do not share financial information with their employees. The goals and measures employed may have to be adjusted to be appropriate. For example, an employer may link the bonus payment to items such as number of new customers, percent of repeat customers, or percent of on-time deliveries.
It is important that the employer contribution to the HSA be determined and communicated prior to open enrollment so individuals can maximize their tax-advantaged savings. Remember, employees can contribute to the HSA as well as the employer, providing additional tax savings.
HSAs will grow in popularity over the next several years. The success of these plans will depend directly on the strategies developed by employers, including the use of profit-sharing approaches, and their ability to effectively communicate and execute that strategy.
Jerry L. Ripperger, director of consumer health at the Principal Financial Group in Des Moines, Iowa, is one of the nation's foremost experts on the issue of consumer-driven health care and HSAs. He has worked with congressional and industry leaders on health care reform and ways employers and health insurance carriers can encourage individuals to take more ownership of their health.
Consumer-Driven Decision: Weighing HSAs vs. HRAs, SHRM Online Benefits Discipline, May 2011
401(k)s Hold Lessons for Consumer-Driven Health Plans, SHRM Online Benefits Discipline, August 2008
Easing the Shift to CDH Plans, SHRM Online Benefits Discipline, June 2009
Strategically Controlling Health Costs with High-Deductible Plans, SHRM Online Benefits Discipline, June 2009
Consumer-Driven Health: Communicating CDH Plan Designs, SHRM Online Benefits Discipline, March 2006