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A prescription for rising health care costs: Vendor partnerships

Like most business owners today, you’re probably feeling increasingly ill over the high costs of providing health care for your employees. And rightfully so. According to data cited by the National Coalition on Health Care, employer health insurance premiums in 2004 increased about four times the rate of inflation to more than 11%.

While there’s no panacea for the rapid rise in health care costs, one remedy offering employers at least partial relief involves leveraging health care vendor partnerships.

Less is more

Under traditional managed health care, doctors, hospitals and other providers agree to work together as part of a network. The network, which often represents dozens of vendor relationships, provides health care services to a business’s employees enrolled in the program for a predetermined fee. If employees seek care outside the network, they must typically pay a higher price.

But some employers are bypassing that tried-and-true approach, and are, instead, developing and strengthening relationships with one or a select few health care vendors. In effect, employees may still choose from a variety of health care options — but just from a consolidated group of vendors.

Consolidating the number of health care vendors can offer valuable benefits to both employers and vendors. How? The privileged vendors no longer have to compete with a vast network of other vendors and, therefore, enjoy a more substantial and profitable chunk of business. This subsequently provides you, the employer, with more leverage to negotiate cost savings with those vendors.

Focus on the relationship

When structuring an agreement with a vendor, the overall goal should be to focus on developing a long-term, mutually beneficial relationship. A health care vendor naturally wants to expand its membership base among healthier employee plan participants. On the other hand, your goal is to provide your employees affordable, quality health care coverage. Thus, key objectives to keep in mind when selecting and negotiating with a vendor include:
Reducing program costs. You may be able to get discounts from choice vendors simply by establishing a more strategic relationship with them and having a service agreement in place.

Consider asking about a rate discount in exchange for allowing vendors to market their offerings to your employees. For example, you may allow them to send targeted newsletter communications and promotional flyers, set up an information booth in the office for a day, or host an informational session over lunch.

Improving service quality. The agreement should specify performance expectations for quality of health care services provided. To help motivate vendors, negotiate to pay them based on their performance. For example, while asking them for a lower premium, offer a year end bonus if they meet certain performance expectations — such as faster and more accurate processing of health claims — in cost-effectively serving your employees.

Also try to negotiate with a vendor to provide additional support services or resources free of charge, such as for program enrollment, implementation and ongoing management. As with any agreement, it’s easier to negotiate extra benefits up front than to go back and try to persuade a vendor after an agreement has been finalized.

Feeling a little better now?

While there’s no end in sight regarding rising health care costs, there are creative ways you can continue to provide your employees with the best health care possible without going bankrupt in the process.

Consolidating the number of vendors in your health care program and developing more strategic relationships with them may be a great way for you to find some relief from the problem.
 

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Tax Tips

Keeping your retirement plan in compliance

The rules governing qualified retirement plans are complex and ever-changing. Employers that don’t keep up with these changes risk losing valuable benefits for themselves and their workers. If you don’t update your plan to comply with new laws and regulations or operate the plan properly, your plan could be disqualified. If this happens, your tax deductions for contributions may be disallowed and your employees may be taxed on plan earnings and employee contributions.

Fortunately, an IRS program — the Employee Plans Compliance Resolution System — allows you to correct plan defects and avoid potentially disastrous consequences. You can correct insignificant operational problems at any time, without IRS intervention, through the Self-Correction Program. For more significant defects, you can voluntarily disclose plan failures to the IRS under the Voluntary Correction Program (VCP) or correct the problem in connection with an audit under the Audit Closing Agreement Program.

For more serious defects, VCP is the better solution: If you come forward voluntarily, you pay a set fee based on the number of participants in your plan and receive IRS approval to correct the problem. If you wait until the IRS identifies the defect in an audit, you’ll have to pay hefty sanctions to avoid disqualification.

Should your IRA invest in real estate?

Most people use their IRAs to hold traditional investments, such as stocks, bonds and mutual funds. But an increasing number of investors have turned to real estate in the hope of earning more generous returns. IRAs can invest in real estate, though you’ll probably need to open a “self-directed” IRA to do so.

If you choose to invest in real estate, plan carefully to avoid some hazardous tax traps. The biggest concern is the prohibited transaction rules, which forbid certain dealings between an IRA and its owner or beneficiaries. Among other things, you can’t:

• Sell or lease property to your IRA,
• Buy or lease property from your IRA,
• Lend money to or borrow from your IRA,
• Pledge your IRA (or any part of it) as security for a loan, or
• Provide goods or services to your IRA.

So if you use your IRA to buy rental or rehab property, for example, you can’t provide management or remodeling services either yourself or through a family member or a company you control. If you engage in a prohibited transaction, the IRA will be terminated, and you’ll be hit with taxes and penalties on the entire account balance — even if you used only a portion of the account for the prohibited transaction.

Another potential disadvantage of investing in real estate is that all IRA earnings are taxed as ordinary income, so you’ll lose the advantage of lower capital gains tax rates on real estate held in an IRA. Also, if the IRA borrows funds to acquire the real estate, the rental income will be subject to tax inside of the IRA.

 

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Dipping into retirement savings can be hazardous to your wealth

On average, people today are living longer and retiring sooner. So it’s conceivable you could spend almost as many years in retirement as you do working — which means you’ll need to save more for your golden years in a shorter amount of time.

As your savings grow, you could be tempted to tap your retirement accounts for current needs such as buying a new home or paying unexpected medical expenses. This may seem like a convenient solution, but it can come at a high price.

Retirement plan advantages

Tax-advantaged retirement plans — such as employer-sponsored 401(k) and 403(b) plans and traditional IRAs — allow you to invest pretax dollars that can grow tax-deferred. You don’t pay any income tax until you make withdrawals, and most employer plans also allow your employer to make pretax matching contributions, turbocharging your savings even more.

To encourage retirement saving, the government makes it difficult to touch these funds before you reach age 591⁄2, imposing penalties on most withdrawals before that age.

Your access to retirement funds and the price you pay for withdrawing them depends on the plan type and how you use the money. Generally, with employer plans, you can’t take money out of your account before age 591⁄2 unless you die, become disabled or leave your job.

Early withdrawals

The government recognizes there may be instances requiring you to dip into your retirement savings. Thus, a retirement plan may allow “hardship” withdrawals to pay for:

• Medical expenses for you or your family,
• First-time home purchase expenses,
• Tuition and other higher-education expenses for the next year,
• Expenses to avoid eviction or foreclosure, or
• Funeral expenses for a family member.

Keep in mind that not all plans permit hardship withdrawals, and some allow them only under limited circumstances. Even if you qualify for a hardship withdrawal, you’ll have to pay income tax on the amount withdrawn plus, in most cases, a 10% penalty.

It’s easier to get your money out of an IRA. As long as you’re prepared to pay the taxes and penalties, you can make withdrawals at any time for whatever you want. And there’s no penalty on withdrawals used to pay deductible medical expenses for the taxable year, buy health insurance when you’re unemployed, pay college expenses for the taxable year, pay up to $10,000 toward the purchase of your first home or receive “substantially equal periodic payments” over your life expectancy.

The price you pay

The cost of early withdrawals goes beyond taxes and penalties. Tax-deferred compounding is a powerful financial tool, but it demands a long-term investment horizon. Even a seemingly insignificant interruption can impact your returns.

Let’s say you have $50,000 in a 401(k) plan and you’re 25 years away from retirement. Assuming the plan’s investments earn an 8% return and you make no further contributions, the account will grow to more than $342,000 by the time you retire.

Now suppose your employer allows hardship withdrawals and you take out $10,000 to help pay for your child’s college tuition. If you’re in the 28% tax bracket and under age 591⁄2, the withdrawal will have an immediate cost of $2,800 plus a 10% penalty of $1,000. Suddenly, the $10,000 has shrunk to only $6,200. What’s more, the loss of tax-deferred compounding on the amount you withdraw reduces your retirement savings by more than $68,000.

Borrowing isn’t free

The steep cost of early withdrawals should be enough to dissuade you from dipping into retirement accounts unless you’re out of other options. But what about a loan? Many employer plans (but not IRAs) allow you to borrow as much as half of your vested account balance, up to $50,000. These loans are quick and easy to get, offer competitive interest rates and are payable over five years (longer for certain home loans).

Many people mistakenly believe plan loans are “free” because the interest you pay goes back into your account. But borrowing from a retirement plan comes with significant costs in these three areas:
 

1. Tax-deferred compounding. You lose the benefit of tax-deferred compounding on the amounts you take out of the plan (see above example). And though the funds are returned to the plan with interest, the interest rate on plan loans (usually one or two percentage points over the prime rate) rarely comes close to the returns the money could have earned had it stayed in the plan.
2. Contributions. You may not be able to contribute to the plan during the loan term, either because you can’t afford it or the plan doesn’t allow it. And you’ll also lose any matching contributions your employer would have made and future earnings on the contributions you forgo.
    
3. Loan repayments. If you lose or quit your job, you’ll have to repay the loan quickly — either before you leave the company or within one to three months after. If you can’t, the loan will be treated as a distribution and will be subject to taxes and penalties.

Considerations

Withdrawing or borrowing money from your nest egg can help you in a pinch. But it should be a last resort because of the cost — in terms of taxes, penalties and lost future earnings. Before taking the plunge, see if there are any less expensive alternatives.

Timing is everything

In some circumstances, you can withdraw retirement savings penalty-free to cover qualified medical and college expenses. To avoid the penalty, you must withdraw the funds in the same year you incur the expenses. Taxpayers learned this lesson the hard way in two recent Tax Court cases:

1. Beckert v. Commissioner. A taxpayer withdrew IRA funds in 2001 to pay credit card debt she used for qualified college expenses in 1999 and 2000. Even though she withdrew the funds and used them during the same year, the 10% penalty applied because the expenses were incurred in previous tax years.

2. Duncan v. Commissioner. In 2000, a taxpayer used a 401(k) loan to pay for medical expenses incurred that year. In 2001 the taxpayer left her job, but she was unable to pay back the loan. As a result, the loan was deemed to be a distribution in 2001 and was subject to the 10% penalty. The exception didn’t apply because the medical expenses were incurred in the previous year.


 

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