Health
Savings Accounts (HSAs)
An HSA is a
tax-exempt trust or custodial account similar to an IRA. It allows both
employers and employees to make deductible cash contributions on behalf of
“eligible individuals.” Any HSA withdrawals used to pay medical
expenses that are not deducted for income tax purposes are excluded from the
account beneficiary’s income. These expenses include, in addition to
medical expenses typically covered by group health plans, the cost of
over-the-counter drugs, vision and dental care (including laser eye surgery and
orthodontia) and long-term care insurance premiums. For HSA account
beneficiaries who attain age 65, funds can be withdrawn for any non-medical
purposes without payment of the 10 percent excise tax that otherwise applies to
such withdrawals.
HSAs can be
used to pay medical expenses of family members, including spouses who themselves
are not eligible to set up an HSA, so long as such expenses are not also
reimbursed by another health plan. Medical expenses incurred after the
establishment of the HSA can be reimbursed years later from the HSA so long as
adequate records are maintained by the account beneficiary. Unlike an IRA,
an HSA is not required to make distributions at any particular time and HSA
balances can be retained indefinitely. Consequently, some observers regard
HSAs as attractive retirement savings vehicles.
Individuals
eligible to set up an HSA are those who:
(1)
are covered by a high deductible health plan (HDHP);
(2)
are not covered by any other plan providing general health coverage (this
includes coverage under a spouse’s group health plan, FSA or health
reimbursement account);
(3)
are not enrolled in Medicare (i.e., those who have attained age 65 and have
elected such coverage); and
(4)
are not claimed as a dependent on another person’s tax return.
An HDHP is a
health plan with a minimum annual deductible of $1,000 for individuals (and an
out-of-pocket expense limit of not more than $5,000) and $2,000 for family
coverage (with an out-of-pocket expense limit of not more than $10,000).
With the exception of certain “preventive care” benefits, an HDHP may not
provide benefits until the deductible for the year is met. This means that
after a transition period, separate reduced deductibles for emergency room
treatment and general drug coverage cannot be maintained in an HDHP.
HSA
contributions from all sources are limited during any year to an amount equal to
the applicable deductible up to $2,600 for single coverage and $5,150 for
families (these figures are indexed and increase with increases in the cost of
living). Individuals who have attained age 55 by the end of the year can
contribute an additional $500 per year with respect to 2004 and increasing
amounts in later years. The eligible employee is entitled to an income tax
deduction for contributions within the foregoing limits that are made to the
employee’s HSA by the employee and family members. The deduction is
“above the line” and can be taken regardless of whether or not the
individual itemizes deductible expenses.
An HSA is
intended to cut monthly premium expense through the HDHP and to allow tax
benefits through the payment of medical expenses from the HSA with pre-tax
dollars. Some employers will contribute a portion of their premium savings
to employee HSAs, giving them additional pre-tax dollars to use to pay medical
expenses. By giving each employee a stake in medical expenditures starting
with the first dollar of such expense, HSA participation can help control
overall health care costs. If employees spend less on medical care for
this reason, the HDHP claims experience will be favorable and the rate of health
insurance premium increases could be reduced.
Recommendations:
HSAs are not for everyone. Consider offering an HDHP to employees as an
option to an existing PPO or other group plan. Eligible employees who are
interested can then choose to participate in an HSA. However, it probably
makes sense to wait until 2005 to set up an HDHP. Even the largest
insurance companies have not worked out all the details in their HSA programs,
and it may take time to do so. Further, getting into an HSA now will offer
limited opportunities for participants to realize medical cost savings through
the end of the calendar year, but will still expose participants to
significantly higher deductibles under the related HDHP. Employers and HR
professionals should also consider the significant challenge of analyzing the
details of an HDHP-HSA program and effectively communicating those details
to employees in a timely fashion.
Dated: November
30, 2004
Andrew S. Williams
Aronberg Goldgehn Davis & Garmisa
One IBM Plaza, Suite 3000
Chicago, Illinois 60611
312/755-3145
awilliams@agdglaw.com
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