Investment Guide: Self-Employment

Healthy Choices

Ira Carnahan

The self-employed can get health insurance and tax deductions, too. Here's how.

You dream of being self-employed, but you don't take the plunge for fear of losing your health insurance? Take another look. New tax breaks, laws and insurance pools can help you stay insured at an affordable rate.

The easiest solution to the problem, used by a third of self-employed workers with health insurance, is to have an employed spouse who gets a family policy at work. A 1996 federal law makes this convenient; if you quit your job (or are fired), your spouse has 30 days to put the whole family on his or her workplace policy, even if the employer normally restricts mid-year sign-ups.

If you don't have an employed spouse, yet another federal law, this one called Cobra, can help you make an insured transition to self-employment. Cobra requires companies with 20 or more employees to allow departing workers to continue in the company health plan for 18 months, provided the ex-employee pays the full premium and an administrative charge of 2%. Incredibly, you have up to 105 days after leaving your job to pay the first Cobra premium, with coverage then retroactive. This gives you time to look around to see if you can get a better individual policy.

Why look? While Cobra is a rotten deal for employers, who end up with the sickest ex-employees in their plans, it also can be a poor deal for an ex-employee who is young and healthy. That's because individual policies, unlike the large group kind, are priced according to risk. Healthy young folks pay less.

Robert Deily, of Arlington, Va., resigned as chief financial officer of Swisscom North America in March to start an online software retailer, MBAWare.com. Swisscom had paid 100% of the premium for Deily, 38, his wife, Mary-Ellen, also 38, and their 2-year-old, Matthew. Cobra coverage from Swisscom would have set them back $727 a month. Instead, Deily chose a plan from CareFirst Blue Cross/Blue Shield for $446 a month. In addition to the savings, he liked the idea of signing up with a new insurer while his family was healthy, rather than risk being less insurable in 18 months when Cobra ran out. (Once you buy an individual policy, your right to renew it is protected by law.)

 

If even $446 a month--a typical charge for family coverage--gives you vertigo, try focusing on the aftertax cost. Next year you'll be able to deduct from your self-employment earnings 100% of the health insurance premiums you pay, up from a 70% deduction this year and 30% in 1996. This is a valuable "above-the-line" deduction that can't be snatched back by the Alternative Minimum Tax. Warning: If you are eligible for any employer-subsidized health plan, including your spouse's, you aren't supposed to claim this deduction, even if you aren't on your spouse's plan.

Here's yet another intriguing tax break for the self-employed: a Medical Savings Account, also called an Archer MSA, after the former Ways & Means Committee chairman who championed the idea. An MSA plan has two parts. One is an insurance policy with a high deductible--by law it must be between $1,650 and $2,500 for individual coverage and between $3,300 and $4,950 for a family. The other part is the medical savings account itself, which is funded with pretax dollars and can be used to pay those deductibles and other medical expenses. Individuals can deposit up to 65% of their deductible each year, while families can deposit 75% of the deductible in an MSA. The policy premiums are also 100% tax-deductible as of next year.

Unlike the pretax money contributed to the flexible spending accounts offered by many employers, MSA contributions need not be spent in full each year. Leftover cash can remain in the account and earn interest or even be invested in mutual funds. Any gains go untaxed so long as the funds are eventually used for health care. Once you reach age 65, you're even allowed to withdraw the money for other purposes, without penalty, and pay taxes at the ordinary income rate.

The high deductible makes the MSA insurance affordable. A family plan similar to Deily's but with a $4,950 deductible would run perhaps $225 a month. If you want to switch to an MSA plan, do so at the beginning of a calendar year. The law prorates the dollars you can put into an MSA.


Now that insurance premiums, including the higher ones charged for conventional health plans, are about to be 100% deductible, MSAs have less of a tax edge than when they were created in 1996. Another problem: They've only been authorized by Congress through 2003, raising the possibility you might have to look for a new policy when you're not as healthy. Still, MSAs can be attractive, particularly if you run up big bills for items that aren't covered by regular insurance, such as alternative medical treatments, orthodontia or laser eye surgery. These can be paid from an MSA. Nationally, two of the largest MSA sellers are Golden Rule Insurance and Fortis Health, which also sells its policies through State Farm. Blue Cross/Blue Shield plans in a number of states also offer MSAs.

How do you sort through all your plan options, with their different deductibles, copays and lifetime maximums? Deily turned to Health Insurance Specialists, a Rockville, Md. insurance brokerage, which recommended a dozen plans out of the more than 100 he was eligible for. You can also use an online service--http://ehealthinsurance.com, for example--to generate detailed comparisons. Also be sure to investigate plans offered by the professional associations you belong to. But wherever you decide to buy, first check out the insurer. Make sure it is licensed by your state, and check its financial soundness with a rating firm like A.M. Best (www.ambest.com, free registration required), advises Samuel Bennett, a Columbia, Mo., broker.

Finding a broker you trust can make a big difference. In contrast to products such as whole life insurance, health insurance pays brokers fairly modest commissions--generally 10% or so of the premiums--every month. That means a broker has less incentive to push you into one plan versus another, but also less incentive to spend a lot of time with you parsing every detail of the plans. Still, a good local broker should be able to tell you which insurers have a history of raising rates faster than average or denying legitimate claims, and which are likely to stick around your state--key considerations, since you don't want to have to switch insurers later, when you may not be as healthy.

What if your health is already poor? About 10% of applicants for individual health insurance are rejected outright and another 20% can't qualify for standard-price policies. Don't give up. State legislators and regulators have developed an array of high-risk pools, guaranteed-issue laws and other alternatives. You can get the details at www.healthinsuranceinfo.net, run by Georgetown University's Institute for Health Care Research & Policy. It offers guides to options for each of the states. There's helpful information at the site for the healthy, too.