The cost of tax free health care
Posted by BrianIf you work, pay taxes, and have health care costs then you’ve no doubt heard about - and probably take advantage of - the tax free medical flex accounts. The plans allow you to set aside a predetermined amount of your income into a special account and use that money throughout the year on approved health care expenses. The withheld money is exempt from federal income taxes.
But as usual there is a hitch. At the beginning of the plan year you must determine exactly how much money will be set aside tax free. If you do not use all of that money on health care expenses the balance is forfeited. That’s right - you just flat out lose that money. According to benefit specialists, employees typically forfeit more than $100 each year. It gets worse! You might have to pay taxes on the money that is forfeited.
My wife and I use one of these plans, but while I was sitting in my company’s annual benefits update meeting I was wondering about their true cost.
The first cost to consider is an explicit cost: the administrative fee. My company’s administrator charges about $5 per employee per month. Whether you pay this directly or your employer pays it for you it is part of your total compensation. So, right out of the gate the plan costs each employee $60 per year.
The remaining costs are not explicit, but rather costs associated with lost time. For the purposes of quantifying these costs I’ll use the median income for Madison County, which was about $49,000 in 2004. A typical number of working hours in a year is 2,080, which means that our average person earns $23.56 per hour. For the sake of simplicity I’ll assume this is the taxable income. Using current federal income tax rates the total income tax owed would be $6,567.50 (Imagine if you had to write a check for that amount at the end of the year rather than having the government take your money before it reached your pocket!). The marginal tax bracket is 15% and the effective tax rate is 13.4%.
The time associated with personally dealing with the flex accounts is not negligible. Considerable planning must be done up front to avoid forfeiting money or drastically under utilizing the tax saving potential. Then during the year you must keep track of all associated receipts and frequently must fill out and file a claim form. If your plan administrator issues you a “debit” type card for health care purchases you’ll still be periodically demanded to produce some receipt from a debit card purchase. It’s not easy to quantify the sum total of five minutes here and fifteen minutes there over the course of the year, but I would estimate it to be about 3 hours. That is $70.68 per year for our average Madison County resident.
So the total costs per year are about $131 dollars. It doesn’t sound like much, but since the marginal tax bracket is 15% our average person would have to spend $873 dollars on health care expenses just to break even. Anything less than that and you are losing money. Of course, that doesn’t take into account the frustration associated with filling out forms, filing claims, and dealing with plan administrators when things don’t go smoothly.
As usual, even “good” plans that are built upon our convoluted income tax code result in associated costs and inefficiencies that make them quite a bit less attractive than at first blush.
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June 8th, 2007 at 6:58 pm
Nice write-up… don’t forget the cost if the employee leaves the company before the year is up! For instance, imagine your Madison County citizen chooses to allot $2,000 a year to their cafeteria plan and leaves at the end of June. At that point, they would have contributed $1,000 to the program rather than taking it as compensation. If, for instance, the extra money was put it to pay for junior’s braces scheduled for July (in the “considerable planning phase” of which you speak) and the employee had only used $500 of benefit then the remainder is forfeited… sure hope it’s never taxable income.
However, the squirrelly part is that the employee is perfectly allowed to have spent the whole $2,000 back in January… if that has happened, the company is out the $1,000 and can not collect it from the employee. The employee just eked out an extra $1,000 compensation without having worked for it. I know this doesn’t happen every day, but realistically how many employees leave their jobs at the end of the calendar year? I’d imagine that this adds up to a nice little sum… and less $$$ that the company has to pay for improved performance of other employees who may deserve raises or, God forbid, increased dividends to the shareholders.