It's on Uncle Sam

Making section 125 plans work

It doesn't happen often, but here's a case where the government helps companies save on health-care costs. Section 125 plans let companies and their workers pay for health insurance premiums with pretax dollars. Businesses and employees save 7.65% in FICA and Medicare tax, and workers save on taxes by lowering their taxable income. Yet only about half of companies with 50 or fewer employees participate, compared with almost all companies with more than 200 workers, according to the Kaiser Family Foundation.

Now some states are mandating that all companies set up the plans. In 2006, Massachusetts' health-care reform plan required businesses with 11 or more workers to have a Section 125 plan or pay a fine. Connecticut, Missouri, and Rhode Island followed suit last year, and Maryland and Washington established incentives for small companies to set up. California, Georgia, Minnesota, and New Jersey are expected to add mandates to reform bills now being hashed out in those states. "Why not get the government to pick up the tab?" says Gary Claxton, a policy analyst at Kaiser.

To get started, companies must draft a formal plan, which can be done with the help of an accountant, lawyer, or third-party plan administrator. Fees are several hundred dollars. Some insurance carriers charge less. Or try a company such as Core Documents in Bradenton, Fla., which charges small businesses about $99 to handle paperwork. Companies also must distribute a plan description to all employees.

Premium-only programs are just the plain-vanilla version of Section 125 plans. With a little more effort, companies also can set up flexible spending accounts (FSAs) that allow employees to use pretax dollars to pay for both routine medical expenses and dependent care. FSAs, says Paul Fronstin, a senior research associate with the Employee Benefit Research Institute in Washington, D.C., "are an excellent recruitment and retention tool." Even so, 15% of companies with fewer than 50 employees have an FSA.

FSAs entail a couple of risks. Your company must reimburse each employee for expenses up to the full amount of the plan. So if a worker leaves after undergoing an expensive medical procedure, your business could get stuck with the bulk of the bill. Employees, too, must exercise caution, as any money left at the end of the plan year reverts to the company.

CDI Engineers is one of the few small companies with an FSA. The Lynnwood (Wash.) mechanical engineering firm's 44 employees can put up to $2,400 a year in an account that can fund a range of medical expenses, including over-the-counter drugs and orthodontia, and up to $5,000 in a dependent-care account. Employees contribute via payroll deductions and are reimbursed for their expenses by the firm's third-party administrator. This year about half CDI's staff signed up. "It takes a little while for employees to get it, but once they do, a light goes on," says Vickie Yaros, CDI's business manager. Ralph Murnyak, CEO of Image Base, a 15-employee communications firm in Chicago that has had FSAs for several years, says they are a no-brainer: "The more our employees save, the more we save."

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