If you have a small business in Canada you may wonder from time to time if you are covering your healthcare and dental expenses in the most cost-effective way. You would not be alone. In working with my business clients, I frequently come across entrepreneurs that are not clear on their options in regards to these expenses.
Basically, there are only really three ways to pay for your healthcare and dental expenses:
- You pay for them out of your own pocket with what’s left after you pay taxes;
- You have a traditional group or individual health and dental program; or,
- You use a Health Spending Account.
Does it really matter how you choose to cover these expenses? Fact is, they need to be covered, and as long as you get the health and dental care you need, you will continue to run your business and tend to more pressing matters.
However, one of those pressing matters will eventually be year end accounting and taxes, and this is where how you choose to cover those expenses can make a big difference. Let’s have a look at how these three options have different consequences.
1. Paying your expenses out of your own pocket
This works reasonably well if you pay little to no taxes on your earnings. What happens though, if you are earning enough to pay just 31.5% combined federal/provincial taxes in Alberta? That is the marginal rate you’d pay if you paid yourself $50,000 in 2017.
Let’s say that during the year you ran up healthcare and dental expenses of $1000.00. I think you’d agree that’s pretty easy to do. You pay your bill and go on with life as usual. Whether part of your regular earnings or a special drawing, the cost to your company is $1,459.85 for you to have that $1000.00 in your pocket to begin with. Why? It’s simple, you paid $459.85 in income tax to have $1000.00 in take home pay. That doesn’t include other payments you may need to make such as CPP contributions.
Come tax time you could use those expenses as a deduction and get back some of those tax dollars from CRA, at least that portion that exceeds 3% of your earnings. In this case, that threshold would be $1,500.00, so you won’t get to deduct any of it from your taxes.
This isn’t usually the best way to cover your healthcare and dental expenses.
2. Using a traditional group or individual health and dental program
These programs work well if you prefer to have a third party adjudicate your healthcare and dental expenses, making sure that only certain types of expenses are provided to your employees, and structuring the program to require some cost sharing on the part of your employees. However, this comes at a cost.
Traditional health and dental plans operate on a cost recovery basis. That is, they establish a premium based on a number of factors, including plan design, group size, demographics and claims experience. The premium initially set is then monitored throughout the term of the contract and adjusted at renewal to recover payments that have actually been incurred relative to the targeted loss ratio. We won’t get into details here, as there are simply too many variables.
What we will look at is what the costs typically are in relation to the claim payment received in the hands of you or your employees. Typically, you can expect to pay 145% to 165% in premium relative to the dollars that are returned to plan members through benefit claims.
Let’s look at an example. Assume the same $1000.00 expense we discussed above. After paying the bill, the plan member submits the bill to the insurance company, which would pay a portion of those expenses. Most plans will reimburse 70%, 80% or 90%. Let’s assume 80% in this case, and let’s assume that all services that made up the bill are covered by the plan. Of the $1000.00 spent, the plan member gets back $800.00. The tax free benefit to the plan member is $800.00, while your company may have paid $1160.00 to $1320.00 (145% to 165%) in premium for this benefit. Don’t forget to consider the $200.00 which wasn’t covered by the plan.
The business can deduct 100% of these expenses. While traditional health and dental plans do have some benefits, there is a price to pay, and for many small businesses that price is too high.
3. Using a Health Spending Account
These plans are pretty simple and an excellent way for incorporated businesses to cover the healthcare and dental expenses of their principals as well as their employees.
Health Spending Accounts operate on a reimbursement basis. Members seek reimbursement for expenses that they have incurred. Generally, there is an initial plan enrollment fee, which in most cases is a onetime expense. Some plans charge an additional enrollment fee per employee. Once in place, the cost to the company is the cost of the medical bill being reimbursed plus an administration fee, usually, 10%.
Let’s look at how this would play out using the same example as above. The plan member after paying his $1000.00 bill would submit the receipt to the plan administrator. The plan would reimburse the member the full amount of the bill, $1000.00, tax free. The company would pay the plan administrator the full amount of the bill plus the administration fee, or $1105.00 (please note here the administration fee is subject to GST). In addition, the $1100.00 is a fully tax-deductible expense. That is a win/win.
The average business in Canada using a Health Spending Account to cover their healthcare and dental expenses experience a $1500.00 savings per year, over paying out of pocket or using a traditional health and dental plan. Again, win/win.
Additional considerations with respect to Health Spending Accounts:
Health Spending Accounts also have the most comprehensive list of healthcare and dental expenses that are covered. Literally, everything that Canada Revenue Agency allows to be covered can be processed through a Health Spending Account. That is not the case with traditional health and dental plans, as the various insurance companies design plans around limited coverage and plan member cost sharing.
Health Spending Accounts put the control in the hands of you, the business owner. How much would you like to provide to yourself and your employees? CRA has set some guidelines, but, the control is with you.
If you would like to know more about Health Spending Accounts and how it might fit into your corporate compensation strategy, I’d be happy to answer any questions here.
At Black Edge Advisory we’ve affiliated ourselves with CustomCare, one of Canada’s leading Health Spending Account providers. Based right here in Alberta, CustomCare has been serving Canadian businesses since 1995. A pleasure to work with, CustomCare is always ready to help. Black Edge Advisory and CustomCare, working together to help you save money and taxes on your healthcare and dental expenses. Enroll and start saving today.