Health Spending Accounts in Canada

I’ve got a confession to make. I don’t have health insurance. Ever since I quit my corporate job to start my own business almost 10 years ago, I’ve just been paying out of pocket for any health expenses not covered by the Ontario Health Insurance Plan (OHIP). But because I’ve just turned 40 and am starting to pay more attention to my health, I’ve decided this needs to change.

One of the reasons I love living in Canada is its healthcare system. I know it’s nowhere near perfect, but it does cover a lot. The fact that I don’t have to worry about getting into debt if I need to go to the hospital is something I’ll always be grateful for.

But it doesn’t cover everything, like dental, prescriptions and vision care, which creates some gaps. These gaps are usually covered by your employer’s health insurance plan, or, depending on your age and income level, you may also qualify for programs that can help, like the Canadian Dental Care Plan or the Ontario Drug Benefit Program, for example. 

Bridging the Healthcare Gap When You’re Self-Employed

But I’m self-employed, I’m young-ish, and have a higher income, so I have to bridge those gaps on my own. If you’re self-employed or run a small business in Canada, you may find yourself in the same position, which is what I want to talk about here.

So, if you’re self-employed or run a small business, you’ve got two options to bridge the healthcare gap in Canada: you can buy private health insurance or set up a Health Spending Account (HSA). But don’t get confused by a similarly named program available in the U.S. called a Health Savings Account. That program is a tax-advantaged savings account for individuals to be used to pay for medical expenses. 

We do not have that here in Canada. We have a Health Spending Account in Canada, but it’s only available to businesses. But if you run your own business, as I do, it can not only help you bridge that healthcare gap, but potentially save you thousands of dollars per year.

Private Health Insurance

But first, let’s take a look at private health insurance in Canada. It’s expensive. Maybe not as expensive as, say, the U.S. (I have some friends who are paying $500/month in premiums with $1,000 deductibles for health insurance there), but it’s still pretty costly here.

As an example, I recently spoke with an insurance broker to get a quote from one of the big health insurance providers in Canada. Here’s what I got:

To cover both myself and my husband for prescriptions, basic dental services, paramedical services, travel medical, but no vision care, I was quoted $276/month or $3,312/year. This is actually fairly typical pricing for basic private health insurance in Canada for a healthy couple in our age bracket. 

• 80% of basic dental services up to $1,000/person per year.
• 70% of prescription drugs up to a maximum of $400/person per year.
• $400/year combined for registered therapists, 
• $400/year combined for professional services (physiotherapist, chiropractor, massage therapist) with a cap of $20/per visit.
• $5,000,000 per person for travel medical for trips up to 15 days.
• No vision care.

But, not only is there this added cost of the monthly premiums to consider, but there’s also the strict annual spending limits and coverage amounts. To show you what I mean, here’s how much my husband and I spent last year on out-of-pocket health care costs.

• $1,300 in basic dental
• $250 in prescriptions
• $500 in physiotherapists (4 visits, $125/visit)
• $2,000 therapy

In total, we spent $4,050 out of pocket. Which looks like more than how much private health insurance would have cost us. But don’t forget those coverage caps. If we had insurance, we’d actually be paying this:

• $3,312 for insurance premiums
• $260 for basic dental ($1,040 covered by insurance)
• $75 for prescriptions ($175 covered by insurance)
• $420 for physiotherapists ($80 covered at $20/visit x 4 visits)
• $1,600 for registered therapists ($400 covered)

Total cost with insurance = $5,667

Total cost paying out-of-pocket = $4,050

$1,617 more for insurance than just paying out of pocket.

Looking at these numbers, you can see why I’ve chosen to pay for medical costs out-of-pocket instead of getting insurance. It’s much cheaper. But what I’m kicking myself for now is how much money I could have saved over the years if I’d set up a Health Spending Account.

Health Spending Accounts

A Health Spending Account (HSA), which is a type of Private Health Services Plan (PHSP), was first introduced in 1989 by the Canada Revenue Agency as an alternative to private insurance for small businesses in Canada.

An HSA is an account in which an employer can reimburse employees for health and medical expenses while claiming them as an employee benefit, which is a type of business expense. So, the employer gets a tax deduction, and the employee not only gets reimbursed for their medical costs, but they also don’t have to claim those reimbursements as taxable benefits on their tax return. With that said, in Quebec, HSA reimbursements are treated as taxable benefits to employees for provincial taxes, but remain non-taxable benefits for federal taxes.

Effectively, as a small business owner, it’s a way for you to turn your personal medical expenses into qualified business expenses that are tax-deductible to your business. Another big benefit is that your spouse, common-law partner, or dependents can also claim medical expenses using your HSA. This is great for me because my husband is also self-employed.

How They Work

Let me give you an example to show you how it works. Janet is the sole owner and employee of her incorporated business, ABC Company. After she sets up an HSA, she goes to the dentist and gets charged $200 for a dental cleaning. She pays for it on her personal credit card, then submits her receipt to her Health Spending Account provider. The provider sends a reimbursement for dental cleaning to her personal bank account, then sends an invoice to her corporation for the cost of the medical expense plus an admin fee of between 5-10% of the claim. 

Important to note, some HSA providers charge a one-time account setup fee of between $100-$300, plus sales tax on regular admin fees. The good news is that Janet can write off those admin fees and claim any sales tax paid as input tax credits. 

Tax Savings

But here’s where it gets really exciting. By setting up an HSA, Janet is likely going to save thousands of dollars per year in taxes.

Revisiting how much my husband and I spent last year, and assuming a marginal tax rate of 43.41%, we’d need $7,156.74 in pre-tax income to pay for $4,050 worth of medical expenses. 

But if I’d set up a Health Spending Account, instead we’d be paying with pre-tax dollars, not after-tax dollars. So, assuming an 8% admin fee, we would only need $4,374 to pay those same expenses. 

Put differently, it would only cost us about $300 in HSA admin fees compared to $3,000 in taxes.

Paying Out-of-Pocket with Personal Funds	Paying with Health Spending Account
$4,050 (Medical expenses)	$4,050 (Medical expenses
$3,106.74 (43.41% Marginal Tax Rate)	$324 (8% admin fee)
$7,156.74 (Total funds required)	$4,374 (Total funds required)

But What About the Medical Expense Tax Credit?

Now, I know what you might be thinking. “Can’t I just claim out-of-pocket medical expenses using the federal Medical Expense Tax Credit on my tax return to save on taxes?” Yes, you absolutely can. But it has a high income threshold before it kicks in. You can only use it after your medical expenses exceed 3% of your net income or the dollar threshold, whichever is the lesser amount. 

Since I’m in Ontario, here’s what that would look like:

$4,050 (Medical Expenses) – $2,834 (Threshold) = $1,216 (Eligible Amount) x 14.5% (Federal) + 5.05% (Ontario) = $237.73 in tax savings

I’d only be saving $237.73 in taxes. So using an HSA provides a lot more savings than paying out-of-pocket and using the tax credit.

HSA Guidelines

So, this is all pretty straightforward, right? It seems kind of like a no-brainer to open up an HSA instead of paying out-of-pocket. But there are a few important things you should know before opening up an HSA, including eligibility rules. 

1) Using an HSA, you can only claim medical expenses that qualify under the CRA’s Medical Expense Tax Credit. But honestly, the list is pretty extensive, even more extensive than what most basic private health insurance plans cover. For example, I had a hard time finding private insurance that would cover things like laser eye surgery, adult braces, and IVF. But these all qualify in an HSA.

2) You need to pass the CRA’s reasonableness test when claiming medical expenses. There’s no specific cap on how many medical expenses you can claim in an HSA, but a safe amount is 20% of an employee’s gross salary to avoid the CRA’s scrutiny. Basically, if the amount of medical expenses you claim compared to your income looks excessive, the CRA may surmise that you’re using an HSA as a tax shelter and will deny your tax deductions, which could lead to back taxes, interest, and penalties. 

This is why when setting up your HSA, a pre-determined annual spending limit will be set. Common limits include $15,000/year for executives and owner-managers, and between $1,500 and $5,000/year for employees. These limits also include any claims made by their dependents. And if you don’t use the full amount, a 1-year roll-over rule applies.

3) To become eligible for an HSA, your business needs to earn active business income, not simply passive income (such as dividends, capital gains, or rental income). If you pay yourself 100% in dividends and $0 in T4 salary, the CRA will deny your HSA claim and reclassify it as a taxable shareholder benefit.

For corporations specifically, if you’re the owner and/or shareholder of the company, you need to perform actual operational services for the business and draw a reasonable T4 salary for your work. You can’t just earn dividends from your business. 

4) If you’re a sole proprietor or partnership watching this, the rules are a bit different for you compared to a corporation. That doesn’t mean you’re not eligible, but pay attention to these important rules. 

To qualify, you need to employ at least one arm’s-length employee (so, someone who isn’t related to you), and they must be a full-time employee. You also need to prove that the income you earn from your business is your primary source of income, with it either exceeding 50% of your total personal income, or your personal income from all other non-business sources (such as employment at another company, pensions, or passive investments) doesn’t exceed $10,000.

Moreover, you’ll have much lower limits on how much you can claim in medical expenses in an HSA, compared to corporations. The owner, their spouse or common-law partner, and any adult dependents can’t claim more than $1,500/year each. Dependent children can only claim up to $750/year each. So for a family of four (two adults and two children), the total limit would be $4,500/year.

This is why you may want to watch this video about whether it makes sense to incorporate your business if you’re seriously considering getting an HSA. 

5) Let’s say you still wanted to get private health insurance. For example, you may want insurance to cover things like travel medical services, expensive health emergencies or chronic conditions, which could exhaust your HSA funds.

The good news is, you can use your HSA to pay for your insurance premiums as well as cover any out-of-pocket costs insurance doesn’t cover. This hybrid approach gives you the best of both worlds. Protection against expensive disasters while still using your pre-tax dollars.

What HSA to Choose?

So now you should have a really good understanding of HSAs. But now the hard part is deciding which HSA provider to go with. There are a ton of different options, and everyone online has their opinions. I definitely went down the Reddit rabbit hole and got lost. 

I ended up signing up with Frontier HSA because they had good reviews, they offer a pay-as-you-go model, it was simple to sign up, and their dashboard is really easy to use. But if you want to compare other plans to see which one is the best fit for you, check out these other providers too:

• Frontier HSA
• Olympia Benefits
• Coastal HSA
• EasyHSA
• Brock Health
• CostPlus

And then let me know which one you decide to go with in the comments. I’d love to know why and your experience with them.