Health Savings Accounts: Offering a solution to health care funding
We are living in a day and age where health insurance premiums continue to escalate and health care costs continue to rise. Everyone agrees that something must be done to ease the monetary burden on employers and still allow consumers to receive and pay for the medical services they need. Let’s explore a recent proposed solution for many, which is the Health Savings Account or HSA.
Many employers as well as individuals are turning to health insurance plans with higher deductibles in an effort to save on health insurance premiums. HSAs offer consumers the opportunity to put aside money to pay for routine medical expenses that must be paid out-of-pocket before the deductible is met. For example, you can lower your auto insurance premiums by increasing your deductible. But how many of us set money aside in a savings account to cover that deductible in the event of an accident? That is the point of an HAS— to set aside money to cover medical expenses incurred before the deductible is met.
Background
In 2003, President Bush signed the law establishing the Health Savings Accounts. HSAs are available to any individual or family with qualifying high-deductible health insurance plans (HDHP). There are no income or employment limitations with these accounts.
HDHPs and HSAs work hand-in-hand; however, HDHPs must meet certain annual deductibles in order to be considered HSA-qualified. In 2009, an HDHP must have a minimum annual deductible of $1,150 for individual coverage and $2,300 for family coverage. The maximum annual deductible cannot exceed $5,800 for individual and $11,600 for family coverage. Note: These amounts are indexed for inflation and can increase from year to year.
An HDHP must also limit the out-of-pocket expenses paid by the individual or family for covered benefits under the plan. For 2008 the limit on out-of-pocket expenses is $5,600 for individual coverage and $11,200 for family coverage. Under an HDHP, the deductible, co-pays and coinsurance amounts paid under the plan must count toward meeting the out-of-pocket limit on expenses.
The U.S. Department of Treasury and Internal Revenue Service set the annual HSA contribution limits. These limits are also indexed for inflation annually.
2008 Contribution Limits
$2,900 for individual coverage
$5,650 for family coverage
$900 catch up for age 55-plus
2009 Contribution Limits
$3,000 for individual coverage
$5,900 for family coverage
$1,000 catch up for age 55-plus
In 2009 the catch-up amount will increase to $1,000 and will remain at that amount. These catch-up amounts are set in federal law and are not adjusted for inflation.
The HSA account owner is the same individual who is enrolled in the HDHP. The HSA account is an individual account, and just like with IRAs, joint accounts are not permitted. A married couple, however, where both individuals are eligible, can open two HSA accounts as long as the two HSA accounts do not exceed the maximum contributions allowed for the year.
Contributions
Numerous sources can contribute to an HSA. An employer can contribute to an employee’s account and not pay income or FICA taxes on the contribution. Similarly, the employee will not pay income or FICA taxes on the employer contribution. For the consumer, there is a triple tax savings associated with contributions made to their account. An individual can contribute through a pretax payroll deduction and not have to pay income or FICA taxes. The earnings on these contributions grow tax-free, and as long as the funds are used for qualified medical expenses, taxes never have to be paid on the contribution amounts. Contributions made to the HSA with after-tax dollars can be taken as an above-the-line deduction when the individual files his or her income tax return. If a friend or family member makes a contribution to another individual’s HSA, the recipient can claim a deduction at the end of a year.
The timing of when contributions can be made is flexible. Consumers can fully fund their HSA on Jan. 1 each year or periodically throughout the year. If the account is being funded through payroll deduction, the funding is at the end of each payroll period. Funding for the year does not end have to end on Dec. 31. Just like an IRA, an HSA can be funded until April 15 of the year following the year of coverage by the HDHP.
If your HDHP begins in any month other than January, you can still make the full HSA contribution for the calendar year. For example, if your coverage under the HDHP does not begin until July, you can still contribute the full amount for that year. However, you must keep your HDHP coverage through at least the end of the following calendar year or you may have to pay back some of the contribution (and possibly interest and penalties).
For any year you drop or lose your HDHP coverage before the end of the year, you will not be able to make the full contribution to your HSA. You will need to prorate your contribution for that year. This is done by counting only the months in which you had HDHP coverage on the first day of the month. For example, if you drop your HDHP coverage at the end of June, you would only be able to contribute 50 percent of your allowed contribution for that year.
HSA law allows for a one-time rollover from an IRA to an HSA to assist consumers in getting a jumpstart on building the balance in their HSA. There are no tax repercussions if the transfer is made trustee-to-trustee. The only restriction is that the amount of the rollover cannot exceed the contribution limit set for that particular year. HSAs are often compared to FSAs (flexible spending accounts). There is one very important difference between the two n HSA balance can be rolled over from year to year and is permitted to grow tax-deferred. In contrast, flexible spending account monies must be spent by the end of the year or they are lost or forfeited. It is important to note that you may not have an HSA if you use a flexible spending account to pay for health care costs. However, if the flexible spending account is a restricted FSA, meaning that it only covers dental and vision, then you can have an HSA.
Distributions from your HSA
The entire purpose of having an HSA is to pay for qualified medical expenses. The IRS Web site gives a comprehensive list of qualified medical expenses. HSA funds can be used to cover many items and services that insurance does not cover, including over-the-counter medications, vision care expenses (including laser eye surgery), dermatology services, fertility treatments and much more.
Not only can you use your HSA funds to pay for your own qualified medical expenses but you can also use them to pay for qualified medical expenses incurred by your spouse and dependents. Your spouse and dependents do not need to be covered by your HSA-qualified insurance plan.
If you are planning to use HSA funds for retirement, they can be used to pay for long-term care insurance premiums, monthly premiums for Part A (inpatient hospital), Part B (physician and outpatient) and Part D (prescription drugs).
If you have accumulated a balance in your HSA over time and prefer to use that balance for nonmedical-related purposes in retirement, you can! Once the account owner reaches 65, these funds can be used for any purpose without penalty. The account owner simply pays ordinary income tax on the funds and the earnings, and can then use the funds on whatever he or she wishes to.
You can also reimburse yourself for qualified medical expenses paid out-of-pocket. For tax purposes, you should always keep your receipts and explanation of benefits (EOBs) as proof of using these funds for qualified medical expenses.
Upon the death of the HSA owner, the surviving spouse automatically inherits the HSA account, unless a beneficiary has been specified otherwise. If your spouse has his or her own HDHP, he or she may continue to contribute to the inherited HSA account as if it were his or her own. If the surviving spouse does not have an HDHP, he or she may not contribute to the inherited HSA but may continue to use the inherited account as his or her own HSA to pay for qualified medical expenses.
If the HSA owner is not married at the time of death, the funds in the HSA are no longer treated as an HSA but rather become part of the deceased HSA owner’s estate and are subject to estate taxes. If the beneficiary is an estate, the fair market value of the account (as of the date of death) is taxable on the deceased HSA owner’s final income tax return. Qualified medical expenses incurred prior to death may be reimbursed from the HSA before determining the fair market value of the account.
If funds in the HSA are used for non-qualified medical expenses, there is a 10 percent excise penalty.
Establishing an HSA
Due to their increasing popularity, HSAs can be opened at any willing bank, credit union or other qualified institution. The institution is the “custodian” or “trustee” of your HSA and must abide by banking laws, offer federal deposit insurance for a deposit HSA, and report necessary tax information to the consumer and the Internal Revenue Service.
Opening an HSA is typically quite simple. Depending on the type of HSA account being established, a deposit HSA account is like opening a checking account and an investment HSA is like opening an IRA. Regardless of whether or not an HDHP is through your employer or it is an individual health care plan, you can establish an HSA. An HSA is an individually owned account.
Most custodians and trustees pay interest on your HSA account funds, similar to checking and savings accounts. Generally, this is a tiered interest rate product.
Some institutions may also offer investment options for your HSA. This may be an important consideration as your account balance grows over time. The balance in your HSA can be invested in the same types of investments permitted for IRAs, including stocks, bonds and mutual funds. The options offered can vary by institution.
Custodians and trustees can charge administrative and transaction fees, as well as set other requirements for HSA accounts. These can include things like a minimum deposit requirement, minimum balance requirement, account set-up fees, account maintenance fees and transaction fees. The consumer should research and consider these various costs when deciding which institution to open an HSA with.
Be sure to comparison shop for an institution that will offer a good value for your HSA. After all, these are your dollars that you are saving for your future health care needs. Be sure to consider that some institutions charge high fees that may offset the growth in earnings through interest or investment returns.
You can open and maintain more than one HSA account at different financial institutions. Contributions to the accounts can be as much as you want, as long as the total of both accounts do not exceed the limits for the calendar year. Consider the fees being charged by custodians and/or trustees, as this may not be a wise choice.
HSAs do not solve the problem of higher health care costs, but they do make health care more affordable by providing an alternate way of financing medical coverage. Only time will tell if these accounts become mainstream in our society, but for now they are a reasonable option for paying for health care.
This material is intended to provide accurate information but does contain summary explanations. You should consult your tax and/or investment advisor. Investment products discussed are not FDIC insured, are not bank guaranteed and may lose value.
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