The Rising Cost of Medical Care: How Small Businesses Can Utilize Section 125 to Combat Growing Health Care Costs

By Rashke, Daniel N. | The National Public Accountant, November 2001 | Go to article overview

The Rising Cost of Medical Care: How Small Businesses Can Utilize Section 125 to Combat Growing Health Care Costs


Rashke, Daniel N., The National Public Accountant


The cost of medical care in the United States is rising faster than the General Consumer Price Index (CPI). According to the Bureau of Labor Statistics, between July 1992 and June 1998, medical care inflation exceeded the general CPI by 10.97 percent. Another survey by Watson Wyatt Worldwide has employers reporting health care cost increases of 9.7 percent in 2000, up from 7.5 percent in 1998 and 1999. In addition, many employers expect the costs of insurance and medical care to continue to rise. A survey by the New Jersey Business & Industry Association shows that on average, small businesses spent $4,297 for health insurance for each covered employee in 1998. That is up slightly from $4,161 in 1997. However, nearly 40 percent of the small businesses surveyed said they anticipate their premiums rising by seven percent or more this year. By comparison, two national surveys of businesses found employers expecting premiums to increase by eight and nine percent.

These businesses are not bearing the brunt of these health care cost increases. A Bureau of Labor Statistics survey found that 44 percent of the businesses increased the amount of the employee share of health insurance premiums in 1998, up from 35 percent in 1997. More and more employers are responding to rapidly rising medical costs by passing some of those costs along to employees. Methods for increasing the employee share include setting higher co-payments, raising deductibles and increasing the worker's share of the premium. In addition to passing on some of the increases to their employees, employers are absorbing some of the cost increases. Fortunately for employers and employees, there is an affordable and accessible way to fight the high cost of medical care a Section 125 Cafeteria Plan.

A Section 125 Plan is known by many names (i.e., 125 Plan, FlexPlan, Flexible Spending Plan, Cafeteria Plan, Set-Aside Accounts, etc.). In essence, Internal Revenue Code Section 125 allows employers to establish an employee benefit plan that facilitates payment of medical insurance premiums, out-of-pocket medical expenses, term life insurance and disability insurance by the employees an a pre-tax basis. A participating employee makes an annual dollar election that is divided by the number of payrolls within the plan year to determine the amount per paycheck that will be deducted and Set aside for payment of the elected expenses. A Section 125 Plan benefits both the employer and employee. The employer saves FICA taxes an every dollar that is processed through the plan. That is a savings of 7.65 percent an every dollar run through the plan. For most employers, the savings incurred more than pay for the cost of administering the plan. The employee benefits by reducing his or her taxable wage (W-2), thereby savin g state, federal and FICA taxes an each dollar, and by paying for eligible expenses with pre-tax rather than after-tax dollars.

Dependent Care

In addition to medical expenses, dependent care expenses can also be paid through a Section 125 Plan. Most families with young children easily reach the $5,000 maximum for dependent care. …

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