RSM Resources

"Can’t live with ’em, can’t live without ’em." The old adage has been applied to both men and women alike, but it can also be used to describe how employers sometimes view employee benefit plans.

The cost of employee benefits has been rising by double digits annually — health insurance alone rose 11.2 percent in 2004, according to the Kaiser Family Foundation. Yet employers need to offer benefit plans in order to recruit and retain quality employees.

The good news is that with expanding tax deductions and subsidies, employee benefit plans are less expensive than they seem. And the growing trend toward higher participation in pretax accounts means employer gains are growing.

But the trick is to properly align the right worker-friendly benefits with your company’s strategic objectives.

"Meet the intrinsic needs of your workforce by appealing to their view that your programs dovetail with their personal needs," says Robert Nadel in "Compensation Alternatives: Changes in Business Strategy, Plans and Expectations," a white paper for the Society of Human Resource Management. "Develop strategies that are not only friendly to the workforce, but meet your strategic requirements at the same time."

Tax-deductible business expenses

The move toward employers providing benefits for employees actually dates back more than 50 years — to World War II when wage and price controls prevented employers from boosting salaries to compete for labor. Instead, health insurance and retirement incentives were used to recruit workers. After the war, the federal government modified tax laws to encourage companies to continue providing health insurance.

Today, 86 percent of companies surveyed say they need to offer benefits beyond health insurance in order to stay competitive in the labor market, according to the Health Insurance Association of America. Tax laws continue to expand to reward employers that offer more employee benefits.

A wide range of employee benefits are tax-deductible as business expenses and may also be exempt from Social Security, Medicare and Federal Unemployment Tax (FUTA).

• Accident and health plans are exempt except for certain long-term care benefits.
• Athletic facilities, which must be on the premises and employer operated, are exempt when used primarily by employees and their dependents.
• Bonuses, which must be tangible personal property (not cash or cash-like), based on achievement are exempt up to $1,600.
• Dependent care assistance is exempt up to $5,000.
• Educational assistance is exempt up to $5,250 per employee each year.
• Group life insurance coverage is exempt for the cost of coverage up to $50,000 — provided the business is not a beneficiary of the policy.
• Lodging on business premises is exempt if it’s furnished as a condition of employment.
• Long-term care insurance is deductible when the employer pays the cost of the premium. This is often a benefit provided to a defined group of executives or key employees.
• Meals are exempt if minimal or furnished on the business premises for the convenience of the business.
• Moving expense reimbursements are exempt if the expenses would have been deductible for the employee had the employee paid the movers.
• Transportation or commuting benefits are exempt up to certain limits. The commuter highway vehicle limit is $105 per month, transit passes are capped at $105 per month and qualified parking is exempt up to $200 per month.

These exemptions and limits may not apply to highly compensated employees (those earning more than $95,000 per year) or S corporation employees who are shareholders.

Employers gain from the growth in pretax plans

Pretax plans are an area where employees’ personal needs and employer strategic requirements meet. Pretax plans assist employees because the money they set aside is not subject to income tax or FICA. Employers benefit because they do not have to pay Social Security, Medicare or FUTA taxes on employee contributions (except 401(k) plans which are subject to FICA).

Flexible spending accounts. According to industry professionals, the number of U.S. employers offering FSAs has grown from 12 percent in 1993 to 56 percent in 2005 and is expected to increase to 93 percent by 2010.

Flexible spending accounts (FSAs) have been around for more than 20 years. FSAs allow employees to set aside money for medical and dependent care expenses on a tax-free basis in accounts that are managed by their employers.

Despite lowering the individual’s taxable income, participation numbers had historically been low. Convenience was an issue as well as the "use it or lose it" regulation whereby the individual lost any money in the account that wasn’t used by the end of the year. However, new IRS guidance permits a grace period of 2-1/2 months for claims submission to help minimize forfeitures.

And, FSA rules changed in 2003 making it easier for individuals to spend the money in their accounts. Individuals can now use the funds for nonprescription drugs such as allergy and cold medications and pain relievers.

Debit cards also make FSAs easier to use. The debit cards permit automatic verification of certain transactions and are more convenient than the prior method of submitting receipts and waiting for reimbursement.

Pre-tax premiums. Another trend is making FSAs more desirable. As health care costs increase, accompanying benefits such as dental or vision that traditionally the employer has subsidized are shifting to the employee. Employees are turning to FSAs to cover the additional costs on a pretax basis.

Changes in health plans

Consumer-directed health plans with high deductibles and coverage limits are causing more people to enroll in health-related accounts and shift an increasing volume of money into them.

Health Reimbursement Arrangements. Health Reimbursement Arrangements (HRAs) are tied to high-deductible medical insurance policies and are funded solely by the employer. The employee can carry over unspent money from year-to-year but loses the balance if they leave the company.

Health savings accounts. Health savings accounts (HSAs) were introduced in January 2004. These accounts partner high-deductible insurance policies (requiring an annual deductible of at least $1,000 for individuals or $2,000 for families) with savings accounts that let individuals set aside pretax money up to the amount of the deductible with a maximum of $2,600 per year for individuals or $5,150 for families.

More than 3.2 million workers opened HSAs in 2004, according to a survey by Inside Consumer-Directed Care. Industry professionals expect that national banks will enter the health care market in late 2005 with subsidies designed exclusively for HSA deposits.

With an HSA, individuals place their own pretax dollars into a health account. The employer may or may not contribute a portion. Employers who do contribute to employee’s HSAs generally sponsor half of the deductible.

Individuals can invest their HSA funds just as they would a 401(k) and the money grows tax-free. Funds can be withdrawn at any time to cover qualified medical costs with no income tax or penalties. These funds can be withdrawn for other purposes, but will be subject to income and penalty taxes. Dollars that are not spent or withdrawn stay in the account from year to year, and the employee can take the account with them if they change jobs or retire (including any portion contributed by the employer). Individuals who use the money for non-medical expenses after age 65 will owe income taxes but suffer no penalties.

Supplemental policies. Supplemental policies are also a growing trend. Executive supplemental disability benefits are on the rise, according to The Wall Street Journal, and more individuals are seeking out supplemental health policies that provide a lump sum amount if the owner is diagnosed with a particular condition.

Increasing 401(k) plan participation

Nearly 30 percent of workers who are eligible for 401(k) participation don’t contribute at all, according to the Employee Benefit Research Institute. And the average account contains just $45,000. The challenge for employers is to increase employee participation. One approach is to make 401(k) enrollment automatic, another is to increase the amount of the employer contribution.

Regularly communicating the benefits of a 401(k) plan will also help. "Good information about the need for retirement saving and good plan design can significantly increase participation and contributions," according to a study from Boston College’s Carroll School of Management.

Employers benefit from the Medicare Act

Starting Jan. 1, 2006, employers can receive a 28 percent reimbursement on the cost of retiree prescription-drug plans over $250, up to a subsidy of $1,330 per retiree per year. Employers can estimate what this reimbursement will be worth to them over the lives of the retirees and deduct if from their liabilities — generating accounting gains that boost earnings.

Employers experience benefits from employee stock ownership plans

Employee stock ownership plans (ESOPs) have a couple of unique benefits. They can take on debt — companies can borrow money, buy shares of their own stock from themselves, contribute the shares to the ESOP, and deduct the principal and interest on the loan repayments.

An S corporation with an ESOP can use this benefit to enhance its cash flow to cover other business needs while funding its retirement plan .

Companies aren’t allowed to deduct the dividends they pay out, but C corporations with ESOPs can deduct those dividends if they’re distributed out to participants or used to retire ESOP debt. S corporations get no deduction, but the ESOP can use any dividends it receives to retire the stock acquisition debt.

Dollar-to-dollar comparison

The cost of benefits across all industries averaged 37.6 percent of payroll costs, according to the 2004 Employee Benefits Survey released by the U.S. Chamber of Commerce.

This is to the employer’s advantage if the company finds that a dollar spent on employee benefits has the same or greater recruiting and retention attraction as a dollar of compensation. Here’s why — a dollar of salary costs an employer one dollar plus 7.65 percent Social Security and Medicare taxes (on a salary up to $90,000). A dollar of fringe benefits, however, is one dollar less a potential subsidy and isn’t subject to Social Security and Medicare taxes.

Recognizing and maximizing the available gains can make the cost of employee benefits a less bitter pill to swallow.