Health Savings Accounts (HSAs) offer a unique and perhaps unintended opportunity to create tax-favored savings vehicles similar to IRAs. HSAs were established by the Medicare Modernization Act of 2003 with the intention of encouraging consumer-directed healthcare and providing an alternative source for health insurance coverage. The concept pairs HSAs with High Deductible Health Plans (HDHPs). Individuals and families who are covered by HDHPs and are not covered by other health insurance plans are permitted to fund HSAs as a means of financing the deductible portion of the HDHP.
Congress provided significant tax incentives to support HSAs. Contributions to HSAs are essentially "tax free" and the earnings of the account are "tax free", as explained in more detail below. Individuals who can preserve the HSA, either or through efficient management of the deductible or through the ability to pay the required health care deductible from other sources, are presented with a unique opportunity to create an additional retirement savings plan similar to our IRA. The purpose of this article is to expand both the basic HSA concepts and describe this financial opportunity.
HSHs and HDHPs are a package deal. The HDHP is an otherwise standard health insurance plan but with a "high deductible". HDFPs are defined by statute as plans with minimum deductibles of $1,000 for individuals and $2,000 for families and maximum deductibles of $5,000 for individuals and $10,000 for families. The limits were indexed for inflation when established, so the maximum deductibles for 2006 are $5,250 and $10,500 respectively.
HSAs also have maximum contribution limitations, which were originally established at $2,000 per individual and $5,000 per family. These limits are also indexed for inflation and are $2,700 and $5,450 respectively for 2006. In addition, HSA contribution limitations have catch-up provisions for individuals who are between ages of 55 and 65 which allow an additional $700 contribution for individuals in 2006, $800 in 2007, $900 in 2008 and $1,000 in 2009 and thereafter. Therefore, an individual can contribute up to $3,400 ($2,700 maximum plus $700 catch-up) for an individual HSA in 2006. Since the HDHP maximum deductibles and the HSA maximum contribution do not match, it is possible to have the required deductible exceed the HSA fund.
1. Contributions to HSA are tax favored transactions. They can be accomplished through a combination of:
· Salary reduction contributions by employee,
· Flexible spending account contributions, and/or
· Employer contributions to HSA on behalf of employee.
Employer contributions are deductible by employer and are not taxable to the employee when made by employer. Employee contributions through salary reduction agreements operate to reduce the employee compensation, i.e. they are pre-tax contributions.
2. Non-Taxable Distributions. HSA funds can be withdrawn from the HSA account and used to pay eligible medical expenses on a tax-free basis at any time.
3. Taxation of Other Distributions. HSA funds withdrawn for reasons other than eligible medical expenses are taxable as income to the employee and are subject to the a 10% penalty to an extent they are withdrawn prior to the employee reaching age 59-1/2.
4. Tax-Free Growth. HSA funds accumulate tax free during the existence of the HSA account. If the funds are withdrawn for permissible benefits, the growth is never taxed. If withdrawn for impermissible benefits, taxation is deferred until withdrawal, with the additional 10% penalty for withdrawal prior to age 59-1/2.
5. Permissible Benefits. HSA funds can be used for medical and dental expenses, preventive care, prescription drug plans provided the deductible has been spent, COBRA coverage and long-term care insurance.
Although the tax laws require the purchase of a HDHP as a condition to creating an HSA and the HDHP requires the exhaustion of the deductible in order to qualify for the health insurance coverage, there is no requirement that the HSA fund be used to pay the deductible. One of the touted benefits of HSHs has been the possibility that individuals who judiciously managed their healthcare utilization might be left with HSA funds to carryover to future years, which funds could be used for future medical expenses, including post-retirement expenses.
However, since the use of the HSA is not mandatory, individuals who can afford to pay the deductible expenses from other sources, i.e. essentially out-of-pocket, may then retain the entire HSA fund for fixture needs.
1. The funds can be used for future permissible benefits, including long term care insurance.
2. If the funds are not needed for healthcare costs, they can simply be withdrawn from the account on the same basis as IRA funds, i.e. ordinary income taxation plus the 10% premature withdrawal penalty.
The significant opportunity is that the funds can be used as a savings opportunity similar to IRAs.
HSA TOOL KIT
USI Colburn and the Allegheny County Medical Society have prepared an HSA Tool Kit which:
1. Provides a comparison of HDHPs to standard health insurance plans;
2. Contrasts the premiums for typically available health insurance plans to the combination of the premium for the HDHP and the deductible; and
3. Provides financial projections showing the results obtainable if an individual beneficiary is either able to manage their healthcare expenses to save a portion of the deductible or, in the extreme case, simply pay the medical expenses out-of-pocket and save the entire HSA account. The ability to preserve the HSA accounts until retirement is a significant opportunity for physicians who are in the position to pay for medical expenses out-of-pocket.
Published in the Allegheny County Medical Society Bulletin