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A Quick Look at the Health Savings Account (HSA)
by Al Holifield and Virginia Couch The Health Savings Accounts (HSA) is Congress' latest attempt to promote consumer-driven health care. Though we cannot address all questions we have encountered on the HSA within the confines of this space, this article will provide a brief overview of the eligibility rules, the contribution limits, and the restrictions on the use of HSA funds. For years, employers have had the option of offering a variety of consumer-driven health plans, including flexible spending accounts (FSAs), health reimbursement accounts (HRAs), and medical savings accounts (MSAs). However, many individuals are unable to take advantage of these tax-preferred plans because the plans are not offered by their employers. Moreover, many employees with access to FSAs refuse to participate because of the "use-it-or-lose-it" rule, which results in the forfeiture of any unused funds remaining in the account at the end of the year. Congress attempted to address these two issues with the advent of the HSA. Authorized by Congress as part of the Medicare Prescription Drug, Improvement and Modernization Act of 2003, the HSA is an account that an individual covered by a qualified "high deductible health plan" (HDHP) may make tax-deductible contributions to be used to pay certain medical expenses incurred after January 1, 2004. The HSA does not have to be established by or through an employer. Additionally, the balance in an HSA at the end of the year can be carried forward from year-to-year. Eligibility Basic Rules - An individual is eligible to establish an HSA only if the individual is covered by a HDHP and is not covered by any plan that provides benefits other than preventive care benefits before the high deductible limits of the HDHP are met. An individual who may be claimed as a dependent on another person's tax return, an individual enrolled in Medicare, and an individual who has received medical benefits from the Department of Veterans Affairs at any time during the previous three months cannot contribute to an HSA. Individual eligibility is determined on the first day of each month. If an individual is eligible to establish an HSA but later loses her eligible status, she can no longer contribute to the HSA until she is again eligible. However, she may continue to use previously contributed funds from her HSA to pay qualified medical expenses. High Deductible Health Plan - Generally, a HDHP is a health plan with an annual deductible of not less than $1,000 for an individual or $2,000 for a family and with a maximum out-of-pocket limit of $5,000 for an individual and $10,000 for a family for 2004. These limits may increase annually with a cost of living adjustment. To qualify as an HDHP, the plan cannot provide any benefits (other than preventative care, which is discussed below) until the deductible limit has been met. Furthermore, the plan will be disqualified if it requires an individual or a family to pay out-of-pocket expenses above the applicable maximum limit. The plan is permitted to exceed the maximum out-of-pocket limit if the excess amount applies only to out-of-network charges. The plan may also impose a "reasonable" lifetime limit on benefits. Exception for Preventative Care - In recognizing that preventative care can reduce overall health care costs, Congress provided that an HDHP will not be disqualified if it covers certain preventative care expenses before the deductible is met. These allowed expenses include annual health examinations, routine prenatal care, immunizations, obesity weight-loss programs, smoking cessation programs, and cancer screenings. Temporary Exception for Prescription Drug Coverage - After the HSA deductible limits were first announced many individuals realized they were not eligible to establish an HSA because they were covered by a prescription drug plan that reimbursed expenses before the HDHP deductible limit was met. However, in April 2004 the Internal Revenue Service offered some relief to these individuals by announcing that it will allow an individual who would satisfy the HRA limits except for the prescription drug coverage to contribute to an HSA for months prior to January 1, 2006. After that time, the individual cannot contribute unless the prescription drug coverage is also subject to the high deductible limit. Other Permitted Coverage - In addition to coverage under a qualified HDHP, an individual can also have certain other insurance ("permitted coverage"), such as accident, disability, dental care, vision, workers' compensation, and insurance for a specific disease without losing eligibility. An individual covered by an FSA or an HRA, cannot contribute to an HSA unless the FSA and HRA reimburse only for preventative care expenses and accident, dental care, vision care, disability or long-term care coverage or permits reimbursement of medical expenses only after the minimum annual HSA deductible has been satisfied. Establishing the HSA The HSA regulations require that an HSA be opened with an insurance company, a bank, or another approved HSA trustee or custodian. A quick check of the Internet will reveal a plethora of providers willing to assist an eligible individual with opening an HSA, all for a reasonable fee, of course. The Internal Revenue Service recently published a draft model trust agreement and a draft model custodial agreement that may be used by HSA trustees and custodians. Contribution Limits The maximum amount that can be contributed each year to an HSA is the sum of the limits determined separately for each month, based on status, eligibility, and health plan coverage as of the first day of the month. For 2004, the maximum monthly contribution for an eligible individual with individual coverage is 1/12th of the annual deductible under the HDHP, but not more than 1/12th of $2,600. For family coverage under, the maximum monthly contribution is 1/12th of the annual deductible under the HDHP, but not more than 1/12th of $5,150. The dollar limits will be indexed for inflation. The regulations do permit individuals age 55-65 to make an additional contribution of up to $500 for 2004 (an amount that increases by $100 per year until it reaches a maximum of $1,000). Any contributions in excess of the above limits are subject to a 6% excise tax. Although the maximum contribution limits are determined separately for each month, the actual contributions may be made in lump sum or in multiple deposits. The contributions must be made for a specific year on or before the due date (without extensions) for filing tax returns for that year. Contributions for 2004 must be made on or before April 15, 2005. Qualified Medical Expenses An HSA owner can withdraw funds from the HSA to pay for "qualified medical expenses" of the account owner or his or her spouse or dependents incurred after the established of the HSA. Because of the delay in the publishing of the IRS regulations governing HSAs, an HSA established by an individual on or before April 15, 2005, can be used to reimburse qualified medical expenses incurred on or after the later of (1) January 1, 2004, or (2) the first day of the month the individual became eligible to establish an HSA. Qualified medical expenses are those identified in Internal Revenue Code Section 213(d) as qualified for a medical expense deduction under current tax law. HSA funds cannot be used to pay health insurance premiums unless the premiums are (i) retiree health insurance premiums on an individual who has reached Medicare eligibility, (ii) for COBRA coverage, (iii) for coverage under qualified long-term care insurance, or (iv) for a health during a period in which the individual is receiving unemployment compensation. Any funds withdrawn that are not used for qualified medical expenses are subject to a 10% tax, in addition to regular income tax. After the HSA owner reaches age 65, she can withdraw any remaining balance, pay income tax on the withdrawal, and use the funds in any manner she chooses, without paying the 10% penalty. Summary The above information is a brief summary of the main regulations on the new health savings account. Though the HSA offers an eligible individual an opportunity to address the ever growing costs of health care, before you establish an HSA, you should consult with your legal and tax advisor to determine whether you are eligible and what contribution and usage limits may apply to your specific situation. |