Shelby George, Practice Leader, Benefits Solutions, Manning & Napier
As we noted in part one of this series, since its passage, the Affordable Care Act (ACA) has been a near-constant source of discussion and debate. Largely lost in the shuffle has been the sizable impact that the bill will have on high-earning individuals and small business owners. More specifically, there are important tax considerations for the highly-compensated and small business owners, alike.
One of the hallmark features of the ACA is the establishment of public “exchanges” rolled out as of Oct. 1, 2013— marketplaces—where individuals and employers can purchase health coverage for themselves and their employees. Coverage that is sold on the exchanges is done so on a guaranteed basis, meaning that any individual can and will qualify for coverage at a set rate, regardless of any pre-existing conditions. For this reason, it is likely that public exchanges will drive the average cost of health care coverage higher. As aging individuals and those with pre-existing conditions enter the marketplace, the system may rely on the enrollment of younger, healthier individuals in order to keep the exchanges in balance.
The rollout of these exchanges presents businesses with a number of important decisions. In essence, we believe that organizations must decide between three competing alternatives, effective within the “employer mandate” legislation, subject to roll out in January of 2015:
- The first is to provide an employer-sponsored health care plan
- A second option is to send individual employees to the public exchanges, subjecting the businesses with over 50 employees to a per-employee fine
- A third alternative is to shrink the size of the business’s full-time staff to under 50 employees, alleviating the obligation to provide health coverage
Businesses will be tasked with weighing the costs and benefits associated with each choice, and making the selection that best fits the needs of their organization.
The implementation of the exchanges will also impact high-earning individuals. In an effort to control costs, the ACA provides federal subsidies to offset the cost of coverage purchased on the exchanges. However, the subsidies under the ACA are only available to individuals and families with a household income under 400% of the poverty level—for a family of four, approximately $92,000 per year.1
This means that many clients who are highly-compensated individuals will not automatically qualify for the subsidies. It is important to understand that premiums paid for coverage on the exchange are paid for using after-tax dollars. Considering that in the existing tax environment, tax shelters for health coverage increase as an individual’s income increases, this new way of allotting subsidies can amount to a tax penalty for high-earners.
The combination of potentially higher costs for health coverage on the exchanges and the loss of preferential tax treatment for high earners could also have a significant impact on small businesses. Though small businesses are not subject to the employer mandate come 2015 (that is, they are not penalized for failing to offer coverage), they too will feel the impact of the ACA. Employers wishing to remain competitive will still need a skilled staff, which will require offering competitive compensation packages to attract and retain top talent. Therefore, small business owners may face significant cost increases if they look to increase compensation for key employees, in order to offset the cost increases that those employees will face if they are forced to purchase coverage on the exchange.
With the implementation of the exchanges currently scheduled to begin October 1st, 2013, it is increasingly important for advisors to position themselves as a strategic resource for clients. One way that they can do this is to align themselves with a seasoned team, including benefits consultants, wealth advisors, CPAs or attorneys, as referenced in part one of this series. Such a team can determine the best course of action given your clients’ goals – whether you’re advising highly-compensated individuals or a small business owner.
In the current environment, it is important for these types of clients to understand how adequate retirement and health plan design may actually provide valuable tax shelters and higher tax-deferred savings. Two considerations are Health Savings Accounts (HSAs) and cash balance plans.
HSAs: From an individual perspective, HSAs are consumer-based savings accounts offered to those participants of a high deductible plan. These accounts give an employee more responsibility for managing health care dollars, with the ability to save on a pre-tax basis for current or future qualified health care costs. Qualified participants include those not enrolled in Medicare (generally, under age 65), and these offer employees the ability to roll over unused funds, on year-after-year basis. For higher-earners, these offer a valuable tax shelter with triple tax savings (contributions pre-tax, interest tax-free, and spending tax-free if used for qualified expenses). In addition, regardless of income level, individuals using HSAs also benefit from lower premiums of high deductible health plans.
Cash Balance Plans: Cash balance plans are a great way for small business owners to increase tax-deferred retirement savings. A cash balance plan is a type of defined benefit (DB) plan that can help owners, partners and other highly-paid principals receive annual tax-advantaged allocations well in excess of those allowed in a defined contribution (e.g. 401(k) Profit Sharing) plan alone. Higher annual tax-deferred allocations are attractive to those who are approaching retirement but have not saved appreciably thus far. When paired with a 401(k) profit sharing plan, the combined arrangement can allow some of the highest allowable tax-deductible employer contributions, and provide great design flexibility in terms of crafting different benefit levels for different groups of employees. In light of today’s tax uncertainties and rising health care costs, tax-deferred arrangements like cash balance and 401(k) combination plans can be an attractive offering for small business owners and their highly-compensated employees.
As an advisor focused on solving your clients’ problems, it is beneficial to develop knowledge of solutions-based plan design features such as Health Savings Accounts (HSAs) and Cash-Balance plans. Becoming familiar with these concepts and their purposes can help you to stand out among the competition, and ultimately provide your clients with the additional resources they need to achieve their long-term objectives.