Health Savings Account (HSA)

How they work

Deposits

Deposits to an HSA may be made by any policyholder of a qualified High Deductible Health Plan (HDHP), by an employer on behalf of a policyholder, or any other person. If an employer makes deposits to an HDHP on behalf of its employees, non-discrimination rules apply — that is, all employees must be treated equally. However, if contributions are made through a section 125 plan, non-discrimination rules do not apply. Employers may treat full-time and part-time employees differently, and employers may treat individual and family participants differently. (The treatment of employees who are not enrolled in a HDHP is not considered for non-discrimination purposes.) Also, for 2007, employers may contribute more for non-highly compensated employees than highly compensated employees.

Contributions from an employer or employee may be made on a pre-tax basis through an employer. If this option is not available through the employer, contributions may be made on a post-tax basis and then used to decrease gross taxable income on the following year's Form 1040. The main advantage of making pre-tax contributions is the FICA and FUTA deduction, which amounts to a savings of 7.65% to the employer and employee. Regardless of the method or tax savings associated with the deposit, the deposits may only be made for persons covered under a HDHP, with no other coverage beyond certain qualified additional coverage.

Previously, the annual maximum deposit to an HSA was the lesser of the HDHP deductible or specified IRS limits. As of 2007 plan years, Congress has abolished the lower limit based on the deductible, and the maximum contribution will simply be the statutory limit. The 2007 statutory limits are $2,850 individual and $5,650 family. All contributions to an HSA, regardless of source, count toward the annual maximum. In 2006, the IRS statutory limits are $2,700 for individual plans and $5,450 for family plans.

A catch-up provision also applies for HDHP participants who are age 55 or over, allowing the IRS limit to be increased. In 2007, the maximum catch-up amount is $800 for each person over the age of 54 or under 65.(catch-up amounts are also prorated for partial-year participants).

All deposits to an HSA become the property of the policyholder, regardless of the source of the deposit. Funds deposited but not withdrawn each year will carry over into the next year. If the policyholder ends participation in the HDHP, he or she loses eligibility to deposit further funds, but funds already in the HSA remain available for use.

The Tax Relief and Health Care Act of 2006 signed into law on December 20, 2006, added a provision allowing a one time rollover of IRA assets to be used to fund up to one year's maximum HSA contribution.

Investments

Funds in an HSA can be invested in a manner similar to investments in an Individual Retirement Account (IRA). Investment earnings are sheltered from taxation until the money is withdrawn (and can be sheltered even then, as discussed in the section below).

While HSAs can be "rolled over" from fund to fund, an HSA cannot be rolled into an IRA or a 401(k), and funds from these types of investment vehicles cannot be rolled into an HSA, except for the one time IRA rollover allowed above. Unlike some employer contributions to a 401(k) plan, all HSA contributions belong to the participant immediately, regardless of the deposit source. A person contributing to an HSA is under no obligation to contribute to his or her employer-sponsored HSA, although employers may require that payroll contributions be made only to the sponsored HSA plan.

Withdrawals

HSA participants do not have to obtain advance approval from their HSA trustee or their medical insurer to withdraw funds, and the funds are not subject to income taxation if made for qualified medical expenses. These include deductibles and coinsurance as well as many other expenses not covered under medical plans, such as dental, vision and chiropractic care; durable medical equipment such as eyeglasses and hearing aids; purchase and use of qualifying over-the-counter medications; and transportation expenses related to medical care.

There are several ways that funds in an HSA can be withdrawn. Some HSAs include a debit card, some supply checks for account holder use, and some allow for a reimbursement process similar to other types of insurance. Most HSAs have more than one possible method for withdrawal. The exact method of withdrawal varies from HSA to HSA and can be considered a marketing design issue. Checks and debits do not have to be made payable directly to the provider. However, in the case of an audit, account holders will be expected to provide documentary evidence that the transaction was for a qualified expense in order to avoid making the amount in question subject to income tax plus a 10% tax penalty for early withdrawal.

The 10% tax penalty is waived for persons who have reached the age of 65 or have become disabled by the time of the withdrawal. Then, only income tax is paid on the withdrawal, and in effect the account has grown tax free (similar to an IRA). Medical expenses continue to be tax free.

When a person dies, the funds in their HSA are transferred to the beneficiary named for the account. If the beneficiary is a surviving spouse, the transfer is tax-free.

HSAs vs. other types of medical savings plans

Health Savings Account are similar to medical savings account (Archer MSA) plans that were authorized by the federal government before HSA plans. HSAs can be used with health plans with decreased minimum deductibles, and a higher fraction of the population is eligible to enroll in them. The changes were made in legislation signed by George W. Bush on December 8, 2003. The law went into effect on January 1, 2004.

 HSAs differ in several ways from MSAs. Perhaps the most significant difference is that employers of all sizes can offer an HSA account and insurance plan to employees. MSAs were limited to employers who employed 50 or fewer people.

Benefits

HSA plans can clearly benefit two groups of people, those who are healthy and those who are very unhealthy or have large monthly expenses for medications. This is due to the fact that everything one spends on medications & office visits are credited towards the deductible. Once the deductible is met, HSA plans will pay for medications with the same copay as all other medical expenses. This could limit the maximum out of pocket costs in some cases.

The premium for a HDHP generally is less than the premium for traditional health insurance. A higher deductible lowers the premium because the insurance company no longer pays for routine health care expenses, and insurance underwriters believe that, if Americans see a relationship between medical cost and their bank accounts, they will consume less medical care, shop for bargains, and be more vigilant against excess and fraud in the health care industry. Introducing consumer-driven supply and demand and controlling inflation in health care and health insurance were among the government's goals in establishing these plans.

With HSAs, in catastrophic situations the maximum out-of-pocket expense liability can be less than that of a traditional health plan. This is because a qualified HDHP can cover 100% after the deductible, involving no coinsurance.

HSAs also give the flexibility not available in some traditional health plans to pay on a pretax basis for qualified medical expense not covered in standard or HSA insurance plans. This may include dental, orthodontics, vision, and non-prescription medications such as aspirin.

HSA accounts also have an advantage over Flexible Spending Accounts since deposits are not necessarily tied to expenses in a particular plan or calendar year. They are automatically rolled over for future medical expenses, or may be used to reimburse qualified expenses from prior years as long as the expense was qualified under an HSA plan at the time incurred.

Over a period of time, if medical expenses are low and contributions are made regularly to the HSA, the account can accumulate significant assets that can be used for health care tax free or used for retirement on a tax-deferred basis.

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