How National Health Care Reform Will Affect Federal Employees
The national health care reform bill -- the Patient Protection and Affordable Care Act of 2010 (PPACA) -- became law on March 23, 2010 and will eventually affect the daily lives and bank accounts of every American.
This includes federal employees who will see changes to their health care benefits, most likely starting next January. While it is somewhat early to know precisely what the full impact of PPACA will be, it is not too early to consider some of the financial consequences for federal employees, along with some possible financial planning strategies for managing these consequences.
Perhaps the most significant change for federal employees resulting from PPACA is that adult children between the ages of 22 and 26 will be eligible for federal insurance coverage, beginning in the next benefit plan year which begins Jan. 1, 2011. Under current law, for federal employees who participate in the Federal Employees Health Benefits Program (FEHBP), an unmarried dependent child can be included as part of "self and family" coverage until the child becomes age 22. Starting Jan. 1, 2011, an adult child can remain on the parent's FEHBP plan (as part of "self and family" coverage) at no extra premium cost to the parent. But to retain health insurance coverage through the FEHBP, the child (using current FEHBP eligibility rules for children younger than age 22): (1) must be a tax dependent of the parent and unmarried; (2) be younger than age 27; and (3) must not have access to, or be eligible to join, an employer-sponsored group health insurance plan. Please note: The Office of Personnel Management (OPM) has not issued final rules regarding which 22 - 26 years old will be eligible for the FEHBP. Final eligibility rules should be issued in early fall 2010.
For employees or annuitants whose children become age 22 sometime during 2010, they will have to find an alternative health insurance plan for their children until Jan. 1, 2011 when PPACA becomes law. Under the FEHBP, children turning age 22 are automatically covered under FEHBP for an additional 31 days past their 22nd birthday at no cost to the employee or annuitant. Once 31 days have past, a federal employee can continue FEHBP coverage for their adult child for up to 36 months through the Temporary Continuation of Coverage (TCC) program. Though there is no federal contribution towards the premium, the coverage policy is not subject to underwriting or pre-existing conditions exclusions. The employee pays the full cost of the premium - this includes the employee's portion, the employer's portion, plus a two percent administrative charge. In other words, the employee pays for a dependent child 22 or older 102 percent of the total premium cost of a "self-only" FEHBP plan.
An alternative to the TCC is for an employee to search for an individual health insurance policy for their child. This policy would be used on a temporary basis until next January. Some private health insurance companies offer what is called a "bridge" plan that provides health insurance for an individual for between six to eight months, with a minimum of underwriting and reasonable premium costs, especially for a 22 year old.
The year 2010 will be the last year employees can get reimbursed for over-the-counter (OTC) drugs from their health care flexible spending accounts (HCFSA), health savings accounts (HSAs), or health reimbursement arrangement (HRA) without a prescription. Beginning Jan. 1, 2011, these plans can only reimburse employees for prescribed drugs and insulin. Also, effective Jan. 1, 2013, annual employee contributions to HCFSAs will be capped at $2,500, which is $2,500 less than the current $5,000 maximum.
Effective Jan. 1, 2011, employees under age 65 must pay an additional tax for nonqualified distributions from an HSA. They will pay a 20 percent (rather than the current 10 percent) tax on nonqualified HSA distributions.
Starting in 2013, PPACA could result in higher taxes for many federal employees. The following is a summary of these higher taxes for those affected individuals.
Additional Medicare Hospital Insurance (HI) Tax on High-Income Taxpayers
Under current law, an employee is liable for a Medicare Hospital Insurance (HI) tax equal to 1.45 percent of his or her wages. Beginning Jan. 1, 2013, individuals with incomes above certain thresholds will pay an additional HI tax of 0.9 per cent (Additional Medicare Hospital Insurance (HI) Tax on High-Income Taxpayers). Under current law, an employee is liable for a Medicare Hospital Insurance (HI) tax equal to 1.45 percent of his or her wages. Beginning Jan. 1, 2013, individuals with incomes above certain thresholds will pay an additional HI tax of 0.9 per cent. For an employee, the additional 0.9 percent effectively increases the HI tax from 1.45 percent to 2.35 percent. The 2.35 percent HI tax will be imposed on salaries and wages exceeding $250,000 for married individuals filing jointly. In determining the additional HI tax, the combined earnings of both spouses are considered. The wage or salary base for determining the additional tax for married individuals filing separate returns is $125,000 and $200,000 for any other taxpayer. This additional HI tax is in a sense an additional Medicare payroll tax imposed on "high wage" earners, a not so uncommon occurrence for married federal employees in which both spouses are working and could easily have combined wages exceeding $250,000.
"Unearned Income" Medicare Contribution Payroll Tax
The new legislation imposes a 3.8 percent "unearned income" Medicare tax on
individuals, estates, and certain trusts. For individuals, the tax is equal to
3.8 percent of the lesser of net investment income or the excess of modified
adjusted gross income (MAGI) over the threshold amounts mentioned above
($200,000 for single individuals, $250,000 for married individuals). Individuals
who are above these thresholds will pay an additional 3.8 percent tax on: (1)
income from interest, dividends, nonqualified annuities, royalties and rent; (2)
gross income from a business to which the tax applies, such as rental income
from a rental property; and (3) the net gain from the disposition of certain
property. The tax will not be imposed on CSRS and FERS annuities, military
pensions, TSP distributions and IRA distributions.
The overall result is that the additional 3.8 percent tax will have an impact on federal employees and annuitants who have significant and growing non-retirement investment portfolios. To understand this tax increase and its effects, consider the fact that dividends and long-term capital gains are currently (2010) taxed at 15 percent. In 2011, high-earning individuals will see dividends taxed at "ordinary", rather than "preferential" tax rates. This will result in an increase to a maximum tax rate on ordinary dividends to 39.6 percent. Long-term capital taxes could increase to 20 percent or more. With the additional 3.8 percent Medicare tax, taxes on dividends could nearly triple to 45 percent, from the current 15 percent and to 39.6 plus 3.8 percent or 43 percent in the year 2013. For those employees and annuitants with large portfolios that are generating dividends and capital gains, it may make sense to shift their portfolios to investments generating tax-exempt or tax-deferred income, such as municipal bonds or IRAs.
Itemized Deduction Limitation for Medical Expenses
Under current law, an individual is allowed an itemized deduction for regular tax purposes for unreimbursed medical expenses to the extent that such expenses in total exceed 7.5 percent of an individual's adjusted gross income (AGI). Beginning in 2013, PPACA will increase the threshold for itemizing deductions for unreimbursed medical expenses from 7.5 percent of AGI to 10 percent of AGI. The thresholds for an individual or an individual's surviving spouse who becomes age 65 before the end of the taxable year during 2013 through 2016 will remain at 7.5 percent.
Other changes that will occur as a result of PPACA's passage:
CLASS Act and Long-Term Care Insurance
Effective Jan 1, 2011, a new long-term care insurance program called the "CLASS" (Community Living Assistance Services and Supports) will begin. Employers, including the federal government, may begin collecting premiums as early as Jan. 1, 2011. Intended as a voluntary ("opt-out" program offered by employers, premiums will be paid entirely by employees. The programs will provide individuals with specified limitations as cash benefits of $50 per day or more in order to pay for long term care (LTC) expenses. There is no lifetime limit on benefits, and persons with greater needs in terms of the basic activities of daily living will receive higher benefits. No benefits will be paid until an enrollee has paid premiums for at least five years and no earlier than in 2016, and meets certain other requirements. The program may be a substitute for the federal government's LTC program or LTC insurance from private insurance companies, especially important for those individuals who cannot qualify for the federal government's or a private insurance company's LTC insurance.
Health Care Costs Reported on W-2
Effective Jan. 1, 2011, all employers - including the federal government - must include on an employee's W-2 form the entire cost of employer-sponsored health coverage. Generally, this refers to the total premium cost of health insurance made available by an employer to an employee and that is excluded from the employee's gross income. The requirement is applicable to W-2 forms to be issued in early 2012 for tax years beginning Jan. 1, 2011. This reporting requirement does not change the tax-free treatment of employer-provided health coverage.
Excise tax on high-cost ("Cadillac") health insurance plans, effective Jan. 1, 2018
The Cadillac tax goes into effect for all group plans, including self-insured plans. The tax would be paid by the insurer in the case of a fully insured group or the third party administrator in a self-insured arrangement, but would be passed on directly to the employer. The new law establishes a 40% excise tax on plans with values that exceed $10,200 for individual coverage and $27,500 for family coverage, with higher thresholds for retirees over age 55 and employees in certain high-risk professions. Transition relief would be provided for 17 identified high-cost states. The tax would be indexed annually for inflation using the consumer price index. When determining the values of health plans, reimbursements from FSAs, HRAs and employer contributions to HSAs will be included. The value of stand-alone vision and dental plans will be excluded. In addition the excise tax will not apply to accident, disability, long-term care, and "after-taxed" indemnity or specified disease insurance coverage.
PPACA was signed into law by President Obama on March 23, 2010. A companion package of "fixes" to PPACA, the Health Care and Education Reconciliation Act (HCERA), was signed by the President on March 30, 2010. As noted above, many provisions of the new law are effective in 2010, while others become law during the years 2011 to 2018. In many instance, the legislation is applicable to group plans, "for plan years beginning on or after" a particular date. Since many group plans follow a calendar year, a provision that becomes legally effective in one year may not actually be implemented by a group plan until the following calendar year.
The following summarizes the timeline of the most significant changes resulting from passage of the PPACA and HCERA. Some of these changes will federal employees; some will not.
Provisions Effective in 2010
January 1, 2010
- $250 one-time payment for a Medicare beneficiary enrolled in Medicare Part D who reaches the coverage gap of $2,830 for the year 2010 only.
uly 1, 2010
- 10% excise tax on indoor tanning services.
September 23, 2010
- Extension of health coverage to include adult children through age 26.
- No pre-existing condition exclusion for children under age 19.
- No lifetime limit on the dollar value of essential health benefits.
- Policies may not be cancelled if policyholder becomes sick.
- Certain preventive health care coverage are required.
Provisions Effective in 2011
January 1, 2011
- Employers required to report the total cost of employer-provided health care on an employee's W-2 form.
- Increase to 20% of the additional tax on nonqualified distributions from HSAs.
- Distributions from HSAs, HRAs, or Health Care FSAs for over-the-counter medicines are considered a "qualified" expense only if prescribed by a physician.
- Collection of premiums for CLASS long-term care program may begin.
Provision Effective in 2013
January 1, 2013
- 0.9% additional Hospital Insurance (Medicare) tax on high-income taxpayers.
- 3.8% "unearned income" Medicare contribution tax takes effect.
- Threshold for itemized deduction of unreimbursed medical expenses increases to 10%.
- $2,500 contribution limitation on Health Care FSAs under cafeteria plans.
Provisions Effective in 2018
January 1, 2018
- 40% excise tax on high-cost (Cadillac) health plans.
About the Author
Edward A. Zurndorfer is a Certified Financial Planner, Registered Health Underwriter, Registered Employee Benefits Consultant and Enrolled Agent in Silver Spring, MD and the owner of EZ Accounting and Financial Services, an accounting, tax preparation and financial planning firm also located in Silver Spring, MD. He is an instructor at federal employee retirement seminars throughout the country for the National Institute of Transition Planning, Inc. and writes numerous columns and books on federal employee benefits.