Section 125 Plans and Limited Policies

Health Care Expense Reimbursement Accounts (Section 125 Plans)

Health Care Expense Reimbursement Accounts, also known as Section 125 Plans, are employer-established programs that allow employees to set aside pre-tax income for medical expenses and other qualified costs. These accounts are designed to reduce taxable income while helping employees cover various health-related expenses. The three most common types of these plans are Flexible Spending Accounts (FSAs), Medical Savings Accounts (MSAs), and Health Savings Accounts (HSAs), each with its own set of rules, benefits, and limitations. Below, we’ll take a closer look at these different types of accounts and how they work.

Flexible Spending Accounts (FSA) and Medical Savings Accounts (MSA)

FSAs and MSAs are trust accounts established by an employer that permit the employee to defer pre-tax earnings into a specifically designated account from which the employee may withdraw funds to pay out-of-pocket medical expenses (MSA) or qualified child-care expenses (FSA) with pre-tax dollars. Any money left in the account not used by year end is forfeited to the company, known as the “use it or lose it” rule.

Contributions to these accounts may be made either by the employee, by the employer, or both. If made by an employee, contributions are deductible from income. If made by the employer, contributions are excluded from the employee’s income. Distributions are tax-free if they are used exclusively to pay qualified medical expenses not paid for by insurance, including the costs of hospital stays, doctor visits, dental care, and prescription drugs. However, distributions for other reasons are taxable and may be subject to a penalty.

Health Savings Account (HSA)

Health Savings Accounts became available January 1, 2004. A Health Savings Account is a trust established for the purpose of paying the qualified medical expenses with pre-tax dollars. HSAs are available to any employer or individual who has a high deductible health insurance policy. The IRS defines a high deductible policy as $1,400/year for singles and $2,800/year for families. in 2023 annual contributions into an HSA cannot exceed the amount of the deductible or $7,050 for singles and $14,100 for families, whichever is less.

Sidenote

Know this...

These numbers are indexed and change each year. Therefore, they are not testable. If you see mention of dollar amounts on the exam it will only say “up to IRS limits.”

While HSAs are similar to MSAs, they are superior in many ways.

An individual may establish the account (FSAs and MSA are established by the employer) and most insurance companies, banks, and brokerage firms can act as trustee.

In an HSA, funds not used for current health care expenses are not forfeited, but are retained in the account (even when changing jobs). Unused contributions continue to grow on a tax deferred basis and may be placed in various investments.

The definition of “qualified health care expense” is much more liberal in an HSA than an MSA. It includes such expenses as over-the-counter medication, vitamins, contact lens solution, weight loss/gain supplements, and almost anything else that may be considered health-related.

Plans for section 125

Other Limited Policies

Prescription Coverage

This coverage is usually offered as an optional coverage on a health insurance policy. Typically an insured with prescription drug coverage will present an insurance card to the pharmacy and pay a small amount (co-payment) per prescription. The pharmacy will submit a bill for the balance to the insurance company.

Vision Care

Vision coverage is not readily available in the individual market, but quite common as part of a group benefit package. A typical policy will cover the cost of an annual eye exam and eyeglasses or contacts every two years.

Specific Disease (Dread Disease)

These policies are commonly sold via correspondence (television, newspaper or direct mail). Specific disease policies are written to cover a single “dread disease,” like cancer. This type of policy will cover only that specific disease, but will pay in addition to any other coverage for cancer that may be in force (Medical expense or Medicare). The benefit payable is a stated amount on a daily, weekly, or monthly basis and is not related to expenses incurred or to wages lost while the insured is being treated for the named disease.

Hospital Confinement

Much like a specific disease policy, the benefit of a hospital confinement policy is a stated amount, maybe $250/day, while the insured is hospitalized. However, the benefit is paid regardless of the cause of hospitalization and is in addition to any other coverage in force.

Lesson Summary

Health Care Expense Reimbursement Accounts (Section 125 Plans), Flexible Spending Accounts (FSA), and Medical Savings Accounts (MSA) are established by employers to allow employees to defer pre-tax earnings into designated accounts for medical expenses. Here are some key points about FSAs and MSAs:

Funds are withdrawn to pay out-of-pocket medical expenses (MSA) or qualified child-care expenses (FSA) with pretax dollars.
Any leftover money at the year end is forfeited to the company under the “use it or lose it” rule.
Contributions can be made by the employee, employer, or both, and have tax implications.
Distributions are tax-free if used solely for qualified medical expenses, but may be taxable and penalized for other reasons.

Health Savings Accounts (HSA) are trusts established to pay qualified medical expenses with pre-tax dollars. Here are some points about HSAs:

Available to employers or individuals with high deductible health insurance policies.
Contribution limits are set annually by the IRS and unused funds can be retained, earning interest.
More flexible than MSAs, with a broader range of qualifying health care expenses.

Other limited policy types in the health insurance market include:

Prescription Coverage: Offered on health insurance policies, requires a small co-payment per prescription.
Vision Care: Common in group benefit packages, covering annual eye exams and eyeglasses/contacts every two years.
Specific Disease Policies: Cover single diseases like cancer, paying regardless of other coverage, with fixed benefits.
Hospital Confinement Policies: Provide daily benefits during hospital stays, irrespective of the cause of hospitalization and in addition to other coverage.

Chapter Vocabulary

Definitions

Hospital Confinement Coverage: Coverage that provides a predetermined, fixed benefit or daily indemnity for contingencies based on a stay at a hospital or intensive care facility.
Limited Policy: Policies that provide coverage for vision, prescription drug, and/or any other single service plan or program.
Specified/Dread Disease: Policies that provide benefits only for the diagnosis and/or treatment of a specifically named disease or diseases. Benefits can be paid as expense incurred, per diem or as a principal sum.
Vision limited Policy: Provides benefits for eye care and eye care accessories. Generally provides a stated dollar amount per annual eye examination. Benefits often include a stated dollar amount for glasses and contacts. May include surgical benefits for injury or sickness associated with the eye.