E. Lynn Nichols, CPA, Accountant's World (www. accountantsworld.com)
After cautiously experimenting with Medical Savings Accounts (MSAs) for seven years, Congress has opened the door to tax-free medical care for anyone that can enroll in a High Deductible Health Plan (HDHP) and deposit tax deductible dollars in a Health Savings Account (HSA).
$2,600 is the maximum amount that can be set aside in an HSA by an individual under 55, and $5,150 is the maximum annual contribution for a family account. Obviously, an individual could contribute less if anticipated medical expenses were less, but then some of the plan’s most attractive features would not be fully realized.
While MSA eligibility is restricted to employees of small businesses and the self-employed, HSAs are open to everyone with an HDHP . . . that’s a health insurance plan with an annual deductible of at least $1,000 for individual coverage and $2,000 for family coverage. Employers can provide an HDHP option so that employees can choose between traditional health insurance coverage or a combination of the HDHP and HSA.
This is an either-or decision; to be eligible for an HSA, the individual must also not be covered by any other health plan that is not an HDHP. Employees could also secure their own HDHP using funds deferred through the employer’s Cafeteria plan if the employer does not make an HDHP option available, as long as they also do not have traditional health insurance coverage.
The only people who cannot contribute to an HSA are individuals over 65, or anyone who chooses traditional health coverage instead of opting for an HDHP. As long as allowable annual contributions exceed actual expenses, HSA plans will accumulate funds that can be used to pay for long-term care insurance, medical expenses during a period of unemployment or after retirement, and even to pay medical expenses of a surviving spouse.
Individuals who cannot afford an annual deposit at least equal to the deductible should probably choose to remain in traditional health insurance plans. For those who can afford to fund them, HSAs have many advantages.
The IRS wasted no time in providing guidance so that anyone who wanted to sponsor HSA plans or establish an HSA account could understand how they work. Notice 2004-2 uses 38 questions and answers to explain HSAs and how virtually anyone can establish one.
The Ins and Outs of HSAs
HSAs are established under new Code Section 223 to receive tax-favored contributions by or on behalf of eligible individuals, and amounts in an HSA that are not used to pay eligible medical expenses . . . on a tax-free basis . . . may be accumulated over the years. Funds in the account accumulate during years when the account holder is healthy, and may be drawn down tax free to pay qualified medical expense when illness strikes . . . even after retirement. So, many advisors see the HSA as an additional opportunity for retirement savings.
HSA funds can be used to cover the health insurance deductible and any co-payments for medical services, prescriptions, or products. In addition, they can also be used to purchase over-the-counter drugs and long-term care insurance, and to pay health insurance premiums during any period of unemployment.
Both an HSA and an HDHP may be offered as options under a cafeteria plan. Thus, an employee may elect to have amounts contributed as employee contributions to an HSA and an HDHP on a salary-reduction basis. HDHPs can be offered as an elective option under employer sponsored health insurance plans, and most underwriters of employer-sponsored plans are expected to offer the option.
Contributions to the HSA by an employer are not included in the individual's taxable income, and contributions by an individual are tax deductible. Individuals, their employers, or both can contribute tax-deductible funds each year up to the amount of the policy's annual deductible, subject to a cap of $2,600 for individuals and $5,150 for families. No contributions can be made after age 65.
Individuals between the ages of 55 and 64 can make extra, tax deductible, contributions to their accounts. In 2004, an additional $500 can be added to the HSA by these older individuals, bringing the total that can be set aside, tax free, to $3,100 for individual coverage. Beginning in 2009, an additional $1,000 can be added to the annual HSA contribution.
Investment earnings generated in the HSA account are not taxable. Neither are amounts distributed, so long as they are used to pay for qualified medical expenses, including prescription and over-the-counter drugs and long-term care services, and even the purchase of continued health care coverage for an unemployed individual (via COBRA). Amounts distributed that are not used to pay for qualified medical expenses will be taxable, and subject to an additional 10% tax in order to prevent abuse of an HSA for non-medical purposes.
HSAs are portable, so an individual is not dependent on a particular employer to enjoy the advantages of having an HSA. Like an Individual Retirement Account (IRA), the HSA is owned by the individual, not the employer.
In addition, any amount remaining in the HSA when the individual dies can be left to a surviving spouse, who can use the funds for medical care tax-free, or to another beneficiary who would treat the account proceeds as Income in Respect of a Decedent (IRD).
