Health Spending Accounts Explained

Oct 23, 2022

Traditional health and dental accounts simply don’t work for everyone. A growing and popular trend in group benefits is giving employees more options on how they can use their benefit dollars. An health spending account (HSA) is an effective way to enhance a traditional plan or to provide more choice in a flexible benefits plan.

What is a health spending account in Canada?

To better understand what an HSA is, let’s first start off with what it is not. It is not a traditional employer provided benefit account. It gives your employees complete freedom to utilize their benefits on what they need. Some people need to spend a lot on prescriptions, other don’t use have any at all. Some want as many massages as they can get in a year while others want to pay for their child’s braces.

As the employer, you allocate a set dollar limit that on how much each employee can spend in a year and the employee spends that allotted amount on any allowable medical expense (which the list is quite long and dictated by CRA).

An HSA can be set up as a stand alone plan or it can be used in conjunction with a traditional benefits plan.

What medical expenses are allowed?

Any medical expense that can be claimed on your taxes through vehicles like the Medical Expense Tax Credit, will also be qualified for a Health Spending Account. Click here to view CRAs list of approved expenses.

How does an HSA work?

There are several providers for HSA’s and they all work the same, with minor differences in costs to the employer and how to submit a claim. It is a simple to set up and a simple to use product; below is how our preferred HSA’s work:

  1. The employer sets the maximum limit of expenditure that the employee is allowed to spend in a year. It can be further set up to only allow a set amount per month or semi-annually.
    (for example, you may allocate $2,000/year in total spend but the employee can only spend $1,000 in the first half of the year and $1,000 in the second half of the year … or you can give them the full $2,000 to spend anytime throughout the year)
  2. The employee pays for the medical expense out of their own pocket. (for example they spend $160 on a massage)
  3. The employee then submits the expense for reimbursement via a phone app.
  4. Upon approval of the claim, the amount of the expense, plus a small administrative fee, is withdrawn from the business’ bank account and deposited into the employee’s bank account. This generally is done within 1-3 business days.
  5. The employer now has a 100% deductible expense.

Who can use an HSA?

An HSA plan can be set up for you as the sole employee, as long as you have an incorporated business. If you don’t, then you will need at least 1 non-arm’s length employee (not a family member).

Incorporated business

  • Shareholders (whether it be one or many) need to behave as true employees to be included: They should be able to demonstrate that they are employees by being actively engaged in business activities on a regular and ongoing basis.
  • Shareholders (whether it be one or many) need to be paid as employees: They should be paid some form of salary (T4 income) rather than exclusively through dividends. This provides further demonstration that the shareholder is an active employee, and can also help when justifying ‘reasonable’ benefit limits.

Un-incorporated business

  • Employers need to have at least one ‘qualified’ employee (and not simply an ‘arm’s length’ employee). This is an employee who is not only considered to be arm’s length, but is also full-time, and has been employed by the business continuously for at least three months. An arm’s length employee is someone who works for you and is not related to you by blood (mother, brother, daughter, etc.), by adoption, or by marriage (this includes common-law relationships). Any business partners you may have do not count as qualified employees, nor do temporary or seasonal workers.
  • Owners (whether it be one or many in the case of a partnership) need to behave as true employees. They should be able to demonstrate that they are employees by being actively engaged in business activities on a regular and ongoing basis.

    Owners need to earn their living from their business: In the current tax year (or previous year) more than 50% of their total income must be derived from their business, or, their total income from all sources other than their business should not exceed $10,000.

It can be utilized the employee/owner/shareholder and their spouse (or common-law partner) and dependents.

Be aware:

Some administrators offer HSAs to unincorporated sole proprietors who have no arm’s-length employees and say that their plans satisfy all the rules. Alarm bells should start ringing here. Merely adding a requirement to buy another insurance product, like life or critical illness insurance, is not enough to meet CRA requirements. 

What are the biggest advantages?

For employers, HSAs provide cost certainty — you know up front the maximum of how much the costs will be. Additionally, if there are no claims from one employee, the business isn’t out-of-pocket anything.  

For the sole owner and employee of an incorporated business, your medical costs for you and your family become a tax-deductible expense. Depending on the nature of the business and the income bracket of the entrepreneur, the tax savings could be significant over having no plan in place.

For the employee, there are no deductibles, co-payments, or annual limits on particular kinds of services that some group health plans have (for example, traditional health plans may have a limit of $200 every 2 years for eye glasses but with an HSA they could buy new pair of glasses every year and have it all reimbursed by the plan).  There also is no wait. With traditional plans, there can be a wait to utilize some of the benefits – such as 3 months for dental, 2 years for eye glasses, or 3 years for orthodontics – but with an HSA employees can start claiming their medical expenses as soon as they are added to the plan.

Another benefit is that people with pre-existing health conditions may find it difficult to qualify for some group insurance plans. With HSAs, that’s not an issue — all pre-existing conditions are covered. There is also no age limit. 

Are there any disadvantages to an HSA?

One downside of HSAs is that they are designed to deal with more of the regular, routine types of medical expenses, such as teeth cleaning, prescription drugs and new eyeglasses — not a catastrophic medical issue.

For major (in other words, expensive) health events, traditional group health insurance plans tend to offer more coverage. With group plans, you can end up getting back a lot more than you paid in premiums.

It is also important to note that the employee must first pay for the expense themselves, then it is reimbursed. If the employee is under financial constraints, this can hinder them from utilizing the HSA.

What are the costs of an HSA?

The HSA plans that we utilize only costs are the allotted limit you set for the health spending account per employee plus a small administrative fee added per claim. There are no monthly premiums and no pre-funding required. This means that if no claims are made, you don’t pay anything.  

About the author

  • Pam is the founder and “boss lady” of Savanti Insurance Agency and Savanti Investment Team (attached to PEAK Securities Inc.). She has over 15 years where she specializes in planning, investments, risk management, and tax-effective strategies for clients’ personal and/or corporate financial needs.

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Although this article was written with the utmost care and based on sources deemed reliable, there is no guarantee of its accuracy or applicability to all specific cases. This article is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. All content and information are of a general nature and does not address the circumstances of any particular individual or entity. Many of the issues discussed will vary by province. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. The opinions expressed in this article do not necessarily reflect those of Peak Securities inc.