The Lowdown on HSAs

By Susan Letney

May. 31, 2005

Health savings accounts are fast becoming a popular employee benefit. While not for every employer or employee, more companies are giving serious consideration to offering them as an option in their comprehensive medical packages, and that means more employees are going to be asking about them.

    The Bush administration is a big advocate of health savings accounts. (President Bush recently announced that he has one himself.)

    The rules for establishing health savings accounts are complex, and the devil is in the details

Who can have them
Health savings accounts are federal tax-advantaged, portable U.S. trust accounts that are created in connection with high-deductible health plans for the payment of an employee’s current and future medical expenses. Employers looking for ways to reduce costs for group health coverage are considering offering such a combination as an extra or alternate type of coverage.

    The accounts can be funded by contributions from the employer, the employee or both. Eligible employees may establish an account with or without employer involvement, and amounts invested are owned by the employee, and therefore not subject to “use it or lose it” rules. Employer contributions are not considered wages for tax purposes, nor are they taxable to an employee.

    Most people who set up a health savings account already have health insurance. Generally, any individual who is covered by a high-deductible plan is eligible to participate. The individual cannot, however, be covered by any other health plan that’s not a high-deductible health plan (such as a spouse’s plan). This does not include permitted coverage, such as other plans that provide health coverage for accident, disability, dental, vision or long-term care, or permitted insurance for workers’ comp, automobile or disease insurance.

    An individual cannot be covered by a prescription drug plan that is not a high-deductible health plan.

How to spot a high-deductible plan
A high-deductible plan is defined as any health plan with an annual deductible of at least $1,000 for an individual or $2,000 for a family. Participants can’t obtain payment or reimbursement until the deductible is satisfied.

    Preventive care services may be covered on a no-deductible or low-deductible basis. Preventive care services include periodic health examinations, such as annual physicals; routine prenatal and well-child care; child and adult immunizations; tobacco cessation programs; and obesity and weight-loss programs. They also include a multitude of screening services for diseases and other physical and mental health conditions, as well as the treatment of related conditions during such screenings.

    Depending on their use, some prescription drugs also might be considered preventive. Drugs to treat weight loss and tobacco cessation and to lower cholesterol are considered permissible, while drugs to treat existing illnesses are not. The rules are trickier when it comes to drugs that both prevent and treat illnesses. ACE inhibitors, for example, are considered preventive when used to treat an individual with a history of heart attacks who has fully recovered, but they are considered treatment when used as medicine for those with congestive heart failure.

    As of 2005, a high-deductible health plan can’t have an out-of-pocket expense limit that exceeds $5,100 for individuals or $10,200 for families. It can have lower out-of-pocket expense caps, but participants can’t be required to pay for expenses in excess of out-of-pocket caps.

    The out-of-pocket expense cap is calculated by adding together co-pays, deductibles and other amounts, but not premiums. This does not include amounts in excess of the “usual, customary and reasonable” out-of-pocket limits for non-network services, or reasonable lifetime limits.

Know your limits
The maximum yearly contribution that can be made to a health savings account is whichever is lower: either 100 percent of the annual deductible under the high-deductible health plan or a fixed, indexed amount. For 2005, this amount is $2,650 for individuals and $5,250 for families.

    The health savings account contribution limit must be computed on a monthly basis, and account contributions by employees can be made on a pretax basis through a cafeteria plan. Employees can change their contribution rate throughout the year; in other words, cafeteria plan rules that restrict changes to certain family status events such as a marriage don’t apply. Contributions to a health savings account can start, stop, increase or decrease as necessary.

    Something else to take into account: catch-up contributions. Individuals who reach age 55 by the end of the tax year can make catch-up contributions over and above the limits. The catch-up limit for 2005 is $600. This will increase by $100 annually until it reaches $1,000 in 2009.

    No contributions are permissible for individuals entitled to Medicare benefits.

    Employers can make contributions to employees’ health savings accounts, but are not required to do so. As part of the nondiscrimination rules, employers must make comparable contributions for all employees in the same coverage category, such as hourly employees only.

Don’t spend it all in one place
Health savings accounts can be used to pay for qualified medical expenses as defined by the law for the participant and the participant’s spouse and dependents. If participants are being reimbursed through their health savings accounts, they cannot also be paid by their insurance company. In other words, no double dipping for the same expense.

    Individuals 65 or older can also be reimbursed for their premiums for Medicare Part A, Medicare Part B and Medicare HMO.

    As a general rule, medical expenses can only be reimbursed through health savings accounts if the expense was incurred after the account was established.

Federal income tax advantages
Employer contributions to a health savings account are not taxable to an employee, and employer contributions are not wages for employment tax purposes.

    When an employee contributes to a health savings account but not through an employer-sponsored cafeteria plan, contributions are deductible to the individual in determining gross income. They are also deductible whether or not the individual itemizes other deductions, sometimes known as “above the line.”

    Earnings on amounts held in a health savings account are not taxable, and distributions made for qualified medical expenses are excludible from gross income. Medicare-eligible individuals are also permitted to receive distributions for qualified medical expenses tax-free even though they are no longer able to contribute to a health savings account.

    Distributions that are not for qualified medical expenses are subject to current income taxation and a 10 percent penalty tax. There is no 10 percent penalty if this distribution is made after death or disability or after the individual becomes entitled to Medicare. Distributions because of mistakes of fact–if repaid by April 15 of the next year–will avoid income and penalty taxes.

The ERISA safe harbor
Health savings account are exempt from the requirements (mainly reporting and disclosure requirements) of the Employee Retirement Income Security Act of 1974, as amended, if they meet a “safe harbor” established by the Department of Labor. The safe harbor provides that an employer cannot:

  • Require an employee to set up a health savings account
  • Limit rollovers

  • Impose conditions on use of funds

  • Make or influence investment decisions

  • Say the account is an employee welfare plan

  • Receive money in connection with a health savings account

    Health savings accounts and high-deductible health plans will not fit the bill for every company or employee, but they do have their benefits and will most likely become more common as options in most health plans. The wise move is to stay well-informed.

The information contained in this article is intended to provide useful information on the topic covered, but should not be construed as legal advice or a legal opinion. Also remember that state laws may differ from the federal law.

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