Why is healthcare tied to employment?
One of the smartest decisions the federal government made was compelling employers to collect insurance, taxes, unemployment, and Medicare/Social Security contributions from their employee’s paychecks.
We all had the same reality check when we received our first paycheck. You remember: you worked at a fast food place in high school, and you received $5 per hour. You worked 20 hours, and realistically believed you would receive $100.
That’s the first time you learned about taxes, and the thrill of receiving your first paycheck was tempered by the reality of FICA, or payroll taxes. I don’t know anyone who was prepared for this, and although it wasn’t a lot of money, it just seems all a little unfair, especially to a teenager.
Most successful unions not only negotiate benefits on behalf of their membership; they also force the employer to collect their members’ union dues. Most unions would not survive if they were forced to collect their own dues from union members.
Thus, unions will negotiate a dues check-off with the employer, in which the employer agrees to collect dues on behalf of the unions through the union member’s paycheck. If the union is successful in negotiating a dues check-off provision, they will then receive their dues payments in a lump sum from the employer, instead of the necessity of setting up a billing and collections department within the union administrative offices to facilitate the collection of dues.
If the union does not compel the employer to collect the dues, they basically would need to wait outside the bank while the employee cashes their check and then use their influence to make the employee pay their fair share.
Simply put, it’s much easier for the government to collect premiums and taxes from employers than from each individual employee. Business has the means, the capability, and the infrastructure necessary to administer this program.
Businesses are also responsible for collect payrolling taxes, state unemployment taxes, federal income tax and federal and state unemployment insurance. They are also required to provide and fully fund workers’ compensation benefits. Heavy fines and penalties await those organizations that fail to deliver on these requirements. Unions figured this out years ago.
Why, then, doesn’t it work with healthcare benefits? The incentive is missing. All successful businesses, regardless of size, prepare for the day when they will add employees. They will improve their employee benefits to make employment at their firm more attractive and competitive for the top talent in the job market. These benefits include compensation, health care, bonuses, taxes, tuition reimbursement, retirement programs, 401(k) matching contributions and many other benefits with which we are all very familiar.
The cost to the employer of these programs can be measured as a percentage of payrolls. Workers’ compensation, for instance, averages approximately one percent of total payroll, and health care can average around 15 percent.
When a business plans to make a new hire, it takes the proposed salary for that employee and adds in the total burden percentage for benefits. This gives the company an estimated annual cost for that employee. As an example, if an employee is hired at a salary of $50,000 per year and the total burden rate for benefits is estimated to be 50 percent, or $25,000, the total annual cost of that employee to the company is $75,000.
All companies perform these functions already. Just as the fast food company took out FICA on your first paycheck, businesses are able to adapt their accounting methods to incorporate a system like this immediately, without additional capital to facilitate any sort of change. If we continue to compel business to collect and disburse funds on behalf of the federal government, state and local jurisdictions, benefits, and union dues, we need to realize that businesses are much happier to comply if they are compensated to perform this valuable service.
It is important that businesses be given the incentive to perform these functions. If the federal government is able to create an opportunity for businesses to have a healthy financial hiring environment, where it is less expensive to hire more employees and provide health care benefits, employment would improve, with fewer individuals accessing the federal government programs for assistance with their health care needs.
Employers provide health care as group coverage. Each employee is afforded the same coverage, and all are rated the same, regardless of past illnesses and preexisting conditions. Thus, it is quite simple to calculate the cost per employee, or the burden the employer pays to provide benefits to each employee.
Since all of these benefits are group plans, the costs are spread to each employee equally, regardless of income, need or ability to pay. Most employers offer cafeteria benefit plans, in which the employee can choose a specialized plan within the framework of the overall program offered by the employer. Unfortunately, the choices are often limited, so many plan administrators will offer plans that are substantially more attractive to the insurer, and will price more comprehensive plans out of reach. So, while there is an appearance of choice, they are really leading you into the most advantageous plan for the insurer.
Most companies do not have the in-house expertise to purchase, implement and adequately explain the choices that are provided to employees on an annual basis. Some of this is by design. If the employer makes wrong decisions on coverage or the application of premiums, they could be held accountable for these decisions, with both potential civil and regulatory penalties assessed to the company. So the decisions on health care are generally left to the insurance broker or the insurer themselves from the commencement of the purchase of insurance to the decisions regarding coverage in both broad and specific areas.
Generally, though, health care coverage is much more complicated and intricate for most human resource personnel to understand, so companies tend to rely on the folks selling the program to them for the professional expertise necessary to procure such programs.
THE 15 PERCENT SOLUTION: A MORE DETAILED LOOK AT COST
If we assume again that health care dollars represent 15 percent of payroll to employers, this loosely breaks down as follows:
- Life Insurance – 1 percent
- Short Term Disability (STD)
- Long Term Disability (LTD)
- Accidental Death & Dismemberment (ADD)
- Employee Assistance Program (EAP)
- Dental and Vision
- Total of All: 1.5 percent
- Health Insurance/Comprehensive Medical/HMO/RX: 12.5 percent
Now, let’s say we take this 15 percent and ask each employer to put aside this amount to fund all life, health, disability, dental and vision, giving each employee options as to coverage, levels and amount of insurance they receive. This would give the employer and the employee flexibility in their healthcare planning. Just as important, it would tie the incentive to hire to a truly flexible fringe plan, so that the employer has the opportunity to offer options based on the circumstances of the individual employee rather than trying to find a universal one size fits all solution to life and health benefits.
HOW IT WOULD WORK
Once hired, the employee is steered to a website offering a wide variety of benefits plans, including health, dental, vision, disability, long-term care and life insurance. The employee is then required to select an option that provides health and life insurance; or he/she can opt out under the Affordable Care Act, aka Obamacare, and the employer would have the proper documentation to avoid any fines related to claims arising from employees who state they were not offered coverage.
Note that most health care companies now offer web-based programs that are now able to tie in with the employer’s payroll system (with proprietary safeguards) and the health care company’s claim system. This is certainly not a new or innovative product, and all of the health care plans would have deductibles and co-pay options.
At this point, the employee is free to make the selection of his/her health care. Once the selection is made, the monies left over are credited to a health savings account (HSA), to be used for out-of-pocket expenses, such as co-pays and deductibles. These funds are used through the calendar year, and if there is a balance in the HSA at the end of the year, the employee is given the option of rolling these funds into the HSA for the next calendar year, or rolling the balance into the company-sponsored 401 (k) plan. As in the past, once the employee makes a selection of his or her health care, they are tied into the benefits selected for a period on one year. If needs change, adjustments can be made during the open enrollment period for the next policy year.
Let’s use an example using an employee making $50,000 per year. Upon hire, the employee is steered to the company benefits website. Once the health account is set up, the employee will find his/her account with a balance to spend of $7,500 or 15 percent of his/her salary.
Let’s say this employee is a 30-year-old single male, with an active lifestyle and limited healthcare intervention. He elects a plan with a high deductible and co-pay, a low payout of life insurance, and perhaps a first dollar or lower out-of-pocket for disability.
In this scenario, his annual healthcare, life and disability premium would be approximately $3,000 and the balance would be placed into an HSA. If the employee chooses a $2,000 annual deductible and a 40 percent co-pay and an annual out-of-pocket maximum of $5,000, he will not be unreasonably tapped out should he have a catastrophic incident, such as a broken limb or a concussion. This is similar to current high deductible plans. This situation will also allow for a chronic condition should it arise, but the key is that the employee is banking on his health. If he is right, he can put some money into his 401 (k) to fund his retirement with the remaining funds in the HSA, but he is also hedged against a substantial injury or illness.
Now, let’s say we have the same $50,000 hire, but a 45-year-old male, married with two kids, ages 10 and 13. The wife has chronic asthma, and both children have ongoing medical needs. This employee would probably choose a plan with a lower deductible for healthcare, disability and higher limits for life insurance. This plan may cost $6,000, leaving $1,500 for his HSA. If the employee had to spend more on health care, that amount could be tax deductible on federal taxes. More on that below in the current, though less publicized, donut hole.
In both instances, the employer is able to write off the entire cost of the healthcare benefits, which would then be offered to employees on a tax-free basis. The federal government would calculate a federal tax deduction of 15 percent of total payroll, and the IRS would put regulatory guidelines on the reporting of benefits afforded to each employee.
This is essentially what employers do now when they report pre-tax benefits on an employee’s W-2, reducing the taxable income by the amount of the qualified pre-taxed income. Instead of a complicated tax calculation, the employer would receive a tax deduction based on 15 percent of their entire payroll, regardless of overtime pay, exempt versus non-exempt employees, etc.
Companies could self-insure a portion of the coverage, which would allow for the potential of more savings, and would also encourage employees to take advantage of wellness and preventative medical services, such as annual checkups, smoking cessation, weight control counseling, etc.Self-insuring would lower premium cost and allow employers to offer more programs to encourage a healthy lifestyle for the employees and their families. There would also be tax benefits tied to these programs, which would further encourage a healthy environment and lower long-term medical costs.
All plans would include preventative expenses paid at 100 percent, and employers could be entitled to additional tax credits for encouraging healthy lifestyle and effective work-life balance. The employee would pay for premiums, co-pays, and out-of-pocket expenses from this account.
THE EMPLOYEE TAX BREAK: The Lesser-known Donut Hole
‘As you have probably heard in the press, current Medicare coverage includes the now-infamous “donut hole.” This is how the donut hole works:
- You pay out-of-pocket for monthly Part D premiums all year.
- You pay 100 percent of your drug costs until you reach the $310 deductible amount.
- After reaching the deductible, you pay 25 percent of the cost of your drugs, while the Part D plan pays the rest, until the total you and your plan spend on your drugs reaches $2,800.
- Once you reach this limit, you have hit the coverage gap referred to as the donut hole, and you are now responsible for the full cost of your drugs until the total you have spent for your drugs reaches the yearly out-of-pocket spending limit of $4,550.
- After this yearly spending limit, you are only responsible for a small amount of the cost, usually 5 percent of the cost of your drugs.
The PPACA (Obamacare) will close this donut hole in 2020, but until then, seniors need to pay this additional $1,750 with relief for some, but not all.
There is also a little known donut hole in the current federal tax code, whicht affects all those who incur medical out-of-pocket expenses in excess of what their flexible spending account or health savings account pays. This is a carryover from the days before high deductible plans became the norm, and most individuals and families generally would not incur the type of out of pocket expenses that is the norm today. Currently, an individual or head of household can deduct medical expenses when, and only when, their out-of-pocket medical expenses exceed 7.5 percent of adjusted gross income. So under the current system, the worker making $50,000 per year must incur $3,750 out-of-pocket before these expenses can be written off.
Let’s take the worker who elects to have $5,000 placed in an HSA for additional medical expense, and whose healthcare premium is fully funded by the employer. The worker ends up with out-of pocket expenses of $10,000. The HSA pays $5,000, leaving the employee with $5,000 in additional expenses. First the adjusted gross income is reduced to $45,000 ($50,000 less $5,000 pre-taxed HSA). Because the $5,000 in the HSA has been issued on a pre-taxed basis, the 7.5 percent starts when these HSA monies run out. The 7.5 percent medical threshold is now 7.5 percent of the adjusted gross income of $45,000, or $3,375. This means the employee can write off only that which above this threshold, or $1,625. This reduces the employee’s taxable income to $43,375. Based on 2012 federal tax rates, an employee filing as single would incur a burden of $7,025. With the $5,000 out of pocket expense, and the funded $5,000 in the HSA, the employee is out a total of $17,025.
Now, let’s use the 15 percent Solution:
Same employee: $50,000 per year.
Employer places $7,500 into a 15 percent account.
Employee elects to take a high-deductible plan costing $2,500 per year and leaves the same $5,000 in an HSA. The employee incurs out-of-pocket expenses of $10,000, leaving $5,000 in additional medical expense.
Now, the taxable income stays at $50,000, the benefits are provided by the employer, and the $5,000 paid through the HSA was tax-free income provided by the employer. Thus the employee is out of pocket $5,000.
Because the 7.5 percent threshold has been eliminated, the employee can write off the entire $5,000 out of pocket expense, for a taxable income of $45,000. Again, a single filer, based on 2012 federal income tax rates, would incur a tax burden of $7,438, for a total out-of pocket of $12,438.
These benefits bear repeating:
- The company gets tax savings on benefits they already provide, at a relative rate.
- The employee has $4,587 more in his or her pocket to pump back into the economy.
- The federal government collects $413 more in taxes per person per year.
Under this plan, the employer receives a tax incentive to provide health care benefits, wellness programs, and lowers its overall costs because a healthier workforce lowers the burden on the health care plan, and also lowers the costs in productivity loss due to absences by employees for health reasons. The employee has the opportunity to fund his or her health care, framing their care to their needs and those of their family, and create the opportunity to have it funded entirely by the employer or on a tax-free basis should the need arise to go out-of-pocket for a catastrophic event. The federal government would reap the benefits of increased tax revenue as well as the reduction in disability costs associated with those who cannot work or who may be uninsured at the time of a catastrophic illness or injury.
These funds can be utilized to provide more benefits for those who do not or cannot contribute to the programs, such as the poor, the elderly, or the incapacitated.
One of the best parts of this solution is the simplicity of the tax calculation, which makes it much more transparent for the employer to calculate and plan for their taxes as the tax year progresses, instead of having to wait to see how it all plays out, hoping they won’t owe too much. The inability to plan for taxes can be devastating to the continuity of operations for a business, and can also financially devastate a family dealing with the stress of a chronic or catastrophic medical issue and also an unanticipated high tax bill.
So here’s the question:
- If you could implement a plan in which all employed individuals and their families are insured under the individual’s company health care program
- the plan would be funded by the federal government indirectly through tax incentives
- The plan would actually create additional tax revenues,
- The program can be implemented immediately, utilizing programs that are already in place.
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