If you are self-employed, your income is subject to a 15.3% self-employment FICA tax. Added to a 28% Federal income tax and a 5% state income tax, this could leave you paying nearly 50% of your income to the government. Fortunately, most self-employed people qualify to set up an HRA or Health Reimbursement Arrangement. An HRA can enable your business to reimburse you for health insurance and out-of-pocket medical expenses, and will save you an extra $3,000 each year.
Health Reimbursement Arrangements for the Self-Employed
An HRA is simply an agreement which enables your business to cover employee's medical expenses, including individual health insurance premiums, as a tax-free fringe benefit. This tax benefit was established in Section 105 of the IRS tax code in 1955, when General Electric lobbied for a business reimbursement rule to give it more flexibility in creating employee benefits.
Anyone set up as an S-corp or C-corp qualifies to set up an HRA. If you are a Schedule C or Schedule F sole proprietor, an HRA is allowed if your spouse can work at least part time in the business. You will be setting up an employee benefits package that covers health insurance premiums, disability insurance premiums, long-term care premiums, and even out-of-pocket medical expenses such as dental coverage.
An HRA makes your taxes go down because when you get to write off medical expenses on your Schedule C, you avoid paying Federal income taxes, state income taxes, and the 15.3% FICA self-employment tax. Not only can the business reimburse you for the cost of health insurance premiums, but you can also set up the HRA to reimburse for dental coverage, preventive care, disability insurance, long-term care insurance, and other out-of-pocket medical expenses.
If you are self-employed but do not have an HRA, you can write off your health insurance premiums on your 1040, saving you Federal income taxes. But, you are still subject to FICA and state income taxes for these expenses. You are not able to write off any of the other expenses listed above.
Using an HRA with a Health Savings Account
Some financial advisors do not realize that you can have an HRA along with a Health Savings Account (HSA). You can of course. The only caveat is that the HRA cannot reimburse for expenses that could apply toward the deductible of the HSA, such as doctor visits or prescription drugs. But, it can cover any insurance premiums and preventive care.
The potential savings are substantial. Let's assume a business owner is in a 28% tax bracket, has an HSA plan, and is incurring the following expenses.
- Health insurance premiums - $7,000
- Preventive expenses - $1,000
- Other insurance - $2,000
The self-employed business owner can write off the $7,000 premium on Federal income taxes, saving 28% of that or $1,960. If the HSA is fully funded, an additional $1,582 will be saved off of Federal income taxes and $282.50 from state income taxes. So, in total, the business owner’s taxes will go down by $3,824.50. Once an HRA is set up, the entire $10,000 in expenses listed above can be reimbursed by the business. So, the business owner would be saving a total of $2,800 from Federal income taxes, $500 from state income taxes, and $1,530 in self-employment taxes. The business owner will also get to take advantage of the same $1,960 in HSA tax savings, for a total tax reduction of $6,790.
Smart business owners take advantage of all the tax deductions for which they qualify. You can reimburse health insurance expenses from the beginning of the year, but out-of-pocket expenses only from the date your HRA begins.
In order to purchase Disability Insurance, a person will be required to work with an insurance agent of some sort. Even if you decide to purchase DI directly from a specific company, the person you go through to purchase it must be a licensed agent. The agent you work with may be a Career Agent that is only able to represent one company or a Broker Agent who is capable of representing multiple insurance companies. If you decide to purchase your coverage from a Career Agent, it would be advisable to at least speak with a broker agent as well. Broker agents are more likely to know and properly assess what is available on the market. Essentially allowing them to know what product and provisions are truly best for your specific circumstances and occupation.
Prior to actually purchasing a policy there are a few steps you should take to ensure that you find the best option for you. The first is to gather an understanding of Disability insurance and the provisions that distinguish a quality, comprehensive policy from a basic, low-grade policy. The second thing is to find an experienced agent to ensure you are receiving quality and expert advice.
Becoming informed about Disability insurance and the important provisions to have in your policy can be fairly simple. The Internet is filled with websites providing information about Disability insurance. Although many of these sites are mostly concerned with having you complete a quote request form, there are a select handful of sites that truly provide valuable content and quality advice. The following is a list of keywords of which you should have basic knowledge when purchasing your coverage: Noncancelable and Guaranteed Renewable, Own-Occupation definition of disability, Residual Disability, policy riders, policy exclusions and limitations. Although there are other important parts to Disability insurance, learning the details associated with the listed keywords will give any consumer a solid head start in understanding the complexity of Disability insurance.
Finding an experienced Disability insurance broker is a great way of complementing your knowledge of Disability insurance. The agent you work with will be a contributing factor in the Disability insurance policy you purchase. For this reason, it is important to work with an experienced agent who can truly provide you a valued service and worthwhile advice. Although there are many ways of distinguishing whether an agent is experienced with Disability insurance, the following are two simple giveaways:
With DI, experience does not necessarily come with age and years in the financial services industry - it comes from making it a big part of one's business. There are agents who sell more Disability insurance in one year than other agents have sold over their entire careers. The following provides a fair distinction of the experience level of an agent with regard to DI:
- An agent who has sold 1-12 policies probably has very limited experience.
- An agent who has sold 12-25 policies probably has a fairly decent understanding.
- An agent who has sold 25-100 policies can be considered an experienced agent.
- An agent who has sold over 100 policies can be considered a Disability insurance expert.
The second and even more important way of knowing if you are working with an experienced agent is whether he/she tries to sell you a policy based on price, or on quality. Disability insurance is much more detailed than most people expect and having a quality contract is much more important than is the cost. An experienced or expert agent will know this and will be sure to portray this to you relatively quickly in your conversation. If your agent is saying this one is cheaper than that one, I would suggest you find a new agent. Prior to looking at pricing, your agent should be concerned with helping you understand the different provisions and the reason why purchasing a quality contract is so important.
More often than not, your gut will lead you in the right direction. If you feel uncertain about the agent you are working with, you should consider looking elsewhere. Unlike Term Life insurance, where pricing is a big factor, DI comes in all sorts of shapes, sizes and quality. When protecting something as important as your income, your family, and your future, it is worth finding a quality agent to work with.
Michael Relvas is an insurance specialist and the owner of MR Insurance Consultants, an insurance services firm in the Washington DC area. He assists professionals nationwide with information and advice on purchasing
. If you have any questions related to your circumstances and/or are interested in reviewing your options, MR Insurance Consultants invites you to call 1-800-817-4522 or visit our
