Healthcare Spending Accounts in Canada: How They Work and Tax Benefits

Healthcare Spending Accounts are growing in popularity as a way for Canadian employers to provide flexible health benefits to employees. Healthcare Spending Accounts allow employees to be reimbursed from a pre-determined amount for eligible medical expenses not covered under other health plans.

But what exactly are Health Spending Accounts, how do they work, and what are the key benefits? Our guide will provide an overview of everything you need to know about Health Spending Accounts in Canada.

What are Health Spending Accounts?

A Health Spending Account (HCSA) is an employer-sponsored plan that provides employees with tax-free funds to pay for eligible medical expenses not covered under other health benefit plans.

With an HCSA, the employer allocates a set dollar amount each year to an account for each participating employee. Employees can use these funds to reimburse themselves for eligible out-of-pocket health expenses.

Employees who incur eligible expenses submit claims and receipts to draw down their HCSA balance. The employer or an administrator then reimburses the employee from HCSA funds.

How Do Healthcare Spending Accounts Work in Canada?

The employer sponsors the HCSA plan and determines the terms, contribution amounts, and expenses that are eligible for reimbursement.

At the beginning of each year, the employer allocates a pre-determined amount to an HCSA for each participating employee. This is often a flat dollar amount for all employees or tiered by employee group.

Employees can submit claims to draw down their HCSA balance and be reimbursed for eligible expenses throughout the year. Expenses reimbursed through an HCSA are not taxable for the employee.

HCSA funds can be used to reimburse out-of-pocket expenses such as:

• Deductibles, co-pays, and co-insurance under health and dental plans
• Services not covered or partially covered under health and dental plans
• Vision care expenses like eye exams, glasses, and contacts
• Prescription drugs
• Paramedical services like massage therapy, chiropractic, and physiotherapy

Any unused HCSA funds at the end of the year may roll over to subsequent years, up to a maximum, if the plan allows it.

After reimbursement, employees must provide supporting documentation such as detailed receipts and explanations of benefits. Expenses must qualify as eligible medical expenses under the Income Tax Act.

The employer or a third-party administrator manages the Healthcare Spending Accounts on the employer’s behalf. They reimburse claims, provide record-keeping, and issue tax information slips if required.

Tax Considerations for Healthcare Spending Accounts in Canada

One of the most significant advantages of a Healthcare Spending Account (HCSA) is its favourable tax treatment.

Under federal tax rules administered by the Canada Revenue Agency (CRA), benefits paid out to employees for eligible medical expenses are generally not considered a taxable benefit.

However, the tax treatment of the employer’s contributions differs for residents of Quebec. For employees taxable in Quebec, Revenu Québec considers the employer’s contributions to the HCSA to be a taxable benefit.

Here are six key tax considerations:

• Employer HCSA contributions are a tax-deductible business expense.
• Federally (outside of Quebec), HCSA benefits are tax-free for employees. In Quebec, employer contributions to an HCSA are considered a taxable benefit for the employee.
• An HCSA is a benefit plan for reimbursing medical costs, not a personal investment account. Its tax advantage comes from the reimbursements being tax-free, not from generating investment income for the employee.
• While employees generally cannot make direct personal top-ups to an HCSA, some plans allow employee contributions through payroll. You may be able to claim these contributions as a medical expense.
• If HCSA funds are used for ineligible expenses, the reimbursed amount becomes taxable income for the employee.
• Any forfeited HCSA amounts that are returned to an employee as a cash payout, rather than being used for future plan contributions or administration, are considered taxable income.

Healthcare Spending Accounts must follow Canada Revenue Agency guidelines for private health services plans to maintain preferential tax status. The plan needs an element of insurance risk, and funds can only be used for eligible medical expenses.

Who Offers Healthcare Spending Accounts?

There are two main avenues to access an HCSA in Canada:

Employer-Sponsored Healthcare Spending Accounts

Most healthcare spending accounts in Canada are offered to their workforce through employers as part of their overall benefits package.

Healthcare Spending Accounts are typically offered in conjunction with traditional group health plans. This gives employees expanded coverage for medical expenses not fully covered under regular benefits.

Employers can offer Healthcare Spending Accounts independently or alongside other account-based plans like health reimbursement arrangements (HRAs). Employers may also offer Healthcare Spending Accounts under a flexible benefits program.

Individual Healthcare Spending Accounts

Some insurance companies and benefits providers offer individual or family plans that function as Healthcare Spending Accounts, which individuals can purchase independently.

These plans are especially valuable for self-employed Canadians and small business owners, where they are formally known as Private Health Services Plans (PHSPs). When set up correctly for a business, the plan’s costs can be a 100% tax-deductible business expense, while the owner and their family receive reimbursements for medical costs completely tax-free.

However, the specific tax rules and eligibility depend heavily on your business structure (for example, whether you are incorporated or a sole proprietor). It is essential to consult CRA guidelines or a financial advisor to ensure a PHSP is a suitable and compliant option for your situation.

What Expenses are Eligible with Healthcare Spending Accounts?

One of the most attractive features of Healthcare Spending Accounts is that they allow reimbursement for a wide range of medical expenses.

Employers can restrict HCSA coverage to certain expenses or reimburse any eligible medical expense. Common expenses include:

Medical Expenses

• Prescription drugs
• Vaccines
• Fertility treatments
• Medical equipment and supplies
• LASIK eye surgery
• Acupuncture
• Ambulance fees

Dental Expenses

• Cleanings, fillings, and other preventative services
• Root canals, crowns, dentures
• Orthodontics like braces and retainers

Vision Care

• Eye exams
• Prescription glasses and contacts
• Laser eye surgery

Other Eligible Expenses

• Physiotherapy, massage therapy, and chiropractic
• Hearing aids and batteries
• compression stockings
• Hospital expenses
• Travel costs for medical treatment
• Home care and nursing services
• Medical marijuana (with a prescription)
• Cosmetic procedures (if medically necessary)

Employees can use HCSA funds to cover unpaid balances after submitting a claim through their regular health and dental plans.

What are the Benefits of Health Spending Accounts?

Healthcare Spending Accounts offer advantages for both participating employees and sponsoring employers.

Benefits for Employees

From the employee perspective, here are some of the main benefits of using an HCSA:

• Tax-free way to pay for medical expenses: HCSA funds are not taxed when reimbursed in most provinces. This saves employees up to 40-50% compared to paying out-of-pocket with after-tax dollars.
• Pay for expenses health plans don’t cover: Healthcare Spending Accounts provide expanded coverage beyond regular health benefit plans. Employees can use HCSA funds for dental implants, prescription sunglasses, massage therapy, etc., if they are eligible for expenses.
• Rollover of unused funds: If the plan allows employees to roll over unused HCSA funds from year to year, and save for anticipated expenses.
• Using Funds After Leaving: This depends on your specific plan. Some plans allow a short window to submit claims after your job ends, but it’s not a standard feature. Check your plan booklet to be sure.
• Portable benefit: Employees who leave can take any remaining HCSA balance with them to use for eligible expenses.
• Save premium costs: Employers can offer Healthcare Spending Accounts paired with higher deductible health plans to make benefits more affordable to both parties.
• Member choice: Employees can choose how and when to use HCSA funds for optimal personal utility.

Benefits for Employers

For employers, Healthcare Spending Accounts offer these advantages as part of an overall benefits package:

• Added employee benefits in Canada: Healthcare Spending Accounts allow employers to enhance their benefits offering and stand out. This can aid with talent acquisition and retention.
• Tax deduction: HCSA contributions are tax-deductible for employers. There are no payroll taxes or deductions.
• Cost control: Employers have more control over HCSA costs since contributions are fixed. Healthcare Spending Accounts paired with high-deductible health plans also help manage costs.
• Administration outsourced: Third-party administration minimizes the HR burden of managing Healthcare Spending Accounts.
• Employee satisfaction: Healthcare Spending Accounts allow employees to customize health benefits to suit their needs, likely improving satisfaction.
• Fewer claims issues: Employees manage their own HCSA funds; reimbursement is guaranteed if expenses are eligible. This saves HR time resolving claims.

How Much Does an HCSA Cost?

The overall cost of an HCSA depends on the employer contribution strategy, plan administration fees, and employee utilization.

Employer Contributions

Employers can determine how much to contribute to each employee’s HCSA annually. Common HCSA contribution strategies include:

• Flat dollar amount – e.g. $500 per year per employee
• Percentage of deductible – e.g. 50% of the health plan deductible
• Based on coverage tier – e.g. $300 for singles, $600 for couples, $900 for families
• Percentage of salary – e.g. 0.5% of base salary

The average employer contribution to an HCSA is $850 per employee per year. Higher contributions allow employees to save more for health expenses.

Employee Contributions

Employees cannot contribute directly to an employer-sponsored HCSA with pre-tax money. Additional employee contributions must be made after-tax, eliminating the benefit.

Employers can structure a portion of HCSA funding from employees’ flex dollar credits or salary deductions if they want to implement employee cost-sharing.

Administrative Costs

On top of employer contributions, administering an HCSA plan comes with costs, including:

• Third-party administrative fees – Typically $2 to $6 per member per month
• Promotion and communication expenses
• Tax reporting requirements, if applicable
• Ongoing HCSA management and coordination

Considering contribution amounts and administrative overhead, employers can budget approximately $1,000 to $2,000 per employee annually for an HCSA program.

How to Use and Manage an HCSA?

If offered an HCSA by an employer, employees need to understand how to use the account properly to maximize the benefits.

Submitting Claims

Employees should follow these steps when submitting HCSA claims:

1. Incur an eligible out-of-pocket medical expense.
2. Submit the expense first to any other health plans to receive reimbursement.
3. Determine the unpaid portion of the expense.
4. Complete an HCSA claim form and provide supporting documentation such as detailed receipts and explanations of benefits from other plans.
5. Submit the claim to the employer or HCSA administrator for reimbursement from HCSA funds.
6. Receive reimbursement either by paper check or direct deposit.

Tracking HCSA Balance and Expenses

To effectively manage their HCSA funds, employees should track:

• The HCSA effective date, annual contribution from the employer, and account balance
• Claims submitted for reimbursement and payment received
• Eligible expenses incurred but still need to be reimbursed.
• Receipts and documentation for every claim

Some HCSA administrators provide online portals for employees to view their account balance and activity easily in real-time.

Investing HCSA Funds

Unlike Flexible Spending Accounts (FSAs), unused HCSA funds can accrue year-to-year if allowed by the employer’s plan. Some HCSA custodians allow participants to invest some of these accumulated funds for more significant growth potential.

Investment options rules around minimum balances, applicable fees, and risk vary by HCSA custodian. Employees can discuss participating in an investment HCSA with their employer.

Changing HCSA Coverage

For most group Healthcare Spending Accounts, employees can only adjust their coverage during open enrollment or if they experience a qualifying life event like marriage, divorce, or having a baby.

Employees should understand their company’s specific HCSA plan rules for enrollment changes and life events.

How Healthcare Spending Accounts (HCSA) Compare to Lifestyle Spending Accounts (LSA)

While Healthcare Spending Accounts offer significant advantages, employers can choose from different types of account-based benefit plans.

In Canada, the most common and relevant comparison is between a Healthcare Spending Account (HCSA) and a Lifestyle Spending Account (LSA).

Both plans provide employees with flexible funds from their employer, but they are designed for different purposes and have completely different tax implications. The key differences are:

Eligible Expenses

The core difference lies in what you can use the money for. HCSA funds can only be used for eligible medical, dental, and vision expenses as defined by the Canada Revenue Agency (CRA). LSA funds are for general wellness and personal interest expenses, such as gym memberships, fitness equipment, hobby classes, or financial advice.

Taxation

This is the most important distinction. Money reimbursed to an employee from an HCSA is tax-free (though in Quebec, the employer’s contribution is a taxable benefit). In contrast, any benefit an employee receives from an Lifestyle Spending Accounts is considered taxable income and must be reported on their T4 slip.

Rollover of Funds

HCSA plans often allow employees to roll over unused funds for at least one year, which helps in saving for larger medical expenses. LSA funds are almost always “use-it-or-lose-it,” meaning they expire at the end of the plan year if not spent.

Documentation

To maintain its tax-free status, an HCSA requires official receipts to prove every claim is a valid medical expense. LSAs generally have more relaxed documentation rules.

Pros and Cons of Different Account-Based Plans

Here is a simplified comparison of the advantages and disadvantages of HCSAs and LSAs from an employee’s perspective:

Tips for Getting the Most from an HCSA

For employees offered an HCSA, here are some tips to maximize the value:

Use Healthcare Spending Accounts for Predictable Expenses

Healthcare Spending Accounts work best for predictable medical expenses rather than unpredictable ones. Optimal use cases include budgeting for planned:

• Dental work like implants or orthodontics
• New eyeglasses or contacts
• Ongoing prescription medications
• Physiotherapy visits

Understand Usage Requirements

While Healthcare Spending Accounts are flexible, they come with rules set by the Canada Revenue Agency.

Employees should understand requirements like only using funds for eligible medical expenses and providing proper documentation. Using funds for non-eligible expenses can result in the reimbursement being treated as taxable income, so it’s important to stick to the rules.

Save Receipts

Employees should save all itemized receipts and documentation related to HCSA claims. The Canada Revenue Agency (CRA) can request proof for claims years after they are made. As a general rule, the CRA requires you to keep all supporting tax documents, including these receipts, for a minimum of six years from the end of the last tax year they relate to. (Source)

This ensures you have the necessary proof in the event of an audit. Your plan administrator may also have specific requirements, so it’s always wise to confirm their rules as well.

Consider an HCSA/High-Deductible Plan Combination

Employers can pair a high-deductible health plan with generous HCSA contributions.

This helps employees pay the higher deductible while the employer/employee enjoys premium savings from the high-deductible plan.

The Bottom Line

Health Spending Accounts provide a versatile way for Canadian employers to enhance their benefits offerings and empower employees to pay for medical expenses tax-free.

With expanded eligibility, rollover of unused funds, and high satisfaction, healthcare spending accounts are expected to continue gaining traction as a new breed of tax-advantaged benefit plans in Canada.