Health Savings Accounts (HSAs) - A Portable Health Care Vehicle

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1 Background Health Savings Accounts (HSAs) - A Portable Health Care Vehicle Health Savings Accounts (HSAs) began initially as Medical Savings Accounts (MSAs), also referred to as Archer MSAs, named after Representative Bill Archer TX. These accounts were established as part of Health Insurance Portability and Accountability Act of This proposal was created to help individuals and small companies combat the increasing costs of health care. The accounts were initially designated for individuals that did not have health insurance, individuals that are self-employed or business with 50 or fewer employees. In 2003, in an effort to the relieve pressure being put on the Medicare/Medicaid system, the government expanded the availability of MSAs and changed the name to Health Savings Accounts (HSAs). Unlike MSAs which were only available to small businesses and uninsured individuals, HSAs were expanded beyond MSAs and became available to anyone that was covered by a High Deductible Health Insurance plan, which in 2012 was set at $1,200 for individual coverage and $2,400 for family coverage. Health Savings Accounts (HSAs) provide individuals with the benefits of a savings account which is funded with pre-tax dollars that could be used to pay for qualified medical expenses. 1 Contributions to this savings account could be made by the individual via payroll deductions, or through direct payments to the account. Employers may also provide contributions to an employee s account as part of the employee s total compensation. These Health Savings accounts provided benefits to employees by permitting them to place tax-free dollars into an account to be used for health related expenses. It also provided a roll-over benefit by allowing employees to roll-over unused dollars from one year to the next. This also provided a benefit to employers by reducing employee related health care expenses because employees were assuming more of their own health care expenses through higher deductible insurance policies. Employers could retain these savings or re-invest some or all of the savings into the employee s HSA accounts. Qualifying for an HSA Account In Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, the Internal Revenue Service (IRS) outlines the requirements that need to be satisfied in order to qualify for an HSA Account. In order to qualify for an HSA a person must meet the following requirements: Must be covered under a high deductible health plan (HDHP) Have no other health coverage such as a Flexible Spending Arrangement (FSA) or a Health Reimbursement Account (HRA) Are not enrolled in Medicare 1 Department of the Treasury, Internal Revenue Service, Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, p. 2

2 Cannot be claimed as a dependent on someone else s tax return 2 IRS Publication 969 defines a High Deductible Health Plan (HDHP) as a plan that has: A higher deductible than typical health plans, and A maximum limit on the sum of annual deductible and out-of-pocket medical expenses that you must pay for covered expenses. These out-of-pocket expenses include copayments and other amounts, but do not include premiums 3 Annual limits for minimum annual deductibles and maximum annual deductible and other out-of-pocket expenses are provided in IRS Publication 969 issued for each calendar year. For example, the minimum annual deductible for 2012 was $1,200 for single coverage, and $2,400 for family coverage. For 2013 these amounts were increased to $1,250 for single coverage and $2,500 for family coverage. In addition, the publication also provides annual limits for the minimum annual deductible and other outof-pocket expenses. For 2012 these amounts were $6,050 for single coverage, and $12,100 for family coverage. For 2013 these limits have been raised to $6,250 for single coverage and $12,500 for family coverage. In addition to the tests above related to HDHPs, the IRS stipulated additional exclusions related to HAS accounts. For example, individuals that are covered under a Health Reimbursement Arrangements (HRA), which are employer funded accounts that reimburse employees for out-of pocket medical expenses, or Flexible Spending Arrangements (FSA) would not be permitted to open an HSA. Flexible Spending Arrangements Flexible Spending Arrangements (FSAs) are employer-established plans that permit employees to set aside monies through periodic salary reductions based on a predetermined agreement. These arrangements are offered in conjunction with other health benefits to allow employees to put aside pre-tax dollars to be used to cover qualified medical expenses. These programs are established by employers for the benefit of their employees. Employers have a wide range of flexibility in establishing FSA programs to their employees as part of their overall benefits package. These programs offer significant benefits to employees as a means to provide a vehicle for paying for future medical expenses. Some of these benefits include: Contributions made to an FSA account are made to the account on a pre-tax basis Employer contributions can be excluded from an employee s gross wages Withdrawals made from these accounts can be made on a tax-free basis provided these withdrawals are made to pay for qualified medical expenses Funds can be withdrawn from the account to pay for qualified medical expenses even if you have not deposited the funds in the account. 2 Department of the Treasury, Internal Revenue Service, Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, p. 3 3 Department of the Treasury, Internal Revenue Service, Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, p. 3

3 FSA plans are established at the beginning of each calendar (benefit plan) year. Employees determine their contributions to the plan and the amount to be deducted from their paycheck each period. This amount is set for the entire calendar or benefit plan year. However, like many other benefits provided by employers, a plan change can be made provided there has been a change in family status such as an addition to the family, change in marital status, or change in employment. The contributions made to an FSA are managed in a separate account or set up on a healthcare credit card which can be used to pay for medical expenses or reimburse employees for outof-pocket expenses or co-payments. The employee contributions are made on a pretax basis providing the employee with a significant tax benefit. Companies may also match a portion of employee contributions to an FSA. Some disadvantages of FSA accounts are that they are use it or lose it plans. This means that the amount of contributions an employee makes during the plan year must be used entirely by the end of the plan year or the balance in the account will be forfeited. In addition, FSAs are limited to a maximum dollar amount or percentage of compensation that an employee can contribute. IRS publication 969 states for plan years beginning after December 31, 2012, a cafeteria plan may not allow an employee to request salary reduction contributions for a health FSA in excess of $2,500 4 Health Savings Accounts (HSAs) Health Savings Accounts (HSAs) are similar to Flexible Spending Arrangements (FSAs) that were initially introduced as Medical Savings Accounts (MSAs) in an effort to relieve the pressure on Medicare, as well as provide individuals with a means of saving pre-tax dollars to be used to pay for health care. Although HSAs are structured very similar to HSAs, there are some additional benefits of HSAs related to the annual contribution limit, as well as excess funds remaining in an individual s account at the end of a benefit plan year. Unlike the concept of use it or lose it which is a part of the FSA structure, HSAs are set up as use it or keep it accounts. This means that a balance that remains in an HSA account at the end of the benefit plan year will remain in an individual s account and be permitted to roll over to the following year. These remaining funds can be used to pay for future medical related expenses and will not have an impact on the contribution limits in the following year. Another significant benefit provided to individuals that contribute to a Health Savings Account versus a Flexible Spending Arrangement is the annual contribution amounts. Under an FSA the annual contribution limit is the lower of $2,500 or a limit set by the employer. Contribution limits may be set higher, but under current IRS rulings a cafeteria plan that does not limit health FSA contributions to $2,500 is not a cafeteria plan and all benefits offered under the plan are includible in the employee s gross 4 Department of the Treasury, Internal Revenue Service, Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, p. 16.

4 income. 5 However, an HSA permits individuals to contribute tax free money to their accounts up to annual limits of $3,250 for single coverage and $6,450 for family coverage for calendar year For calendar year 2014, these limits will be raised to $3,300 for single coverage and $6,500 for family coverage. As an alternative to Flexible Spending Arrangements (FSAs), Health Savings Accounts (HSAs) can provide significant savings and benefits to employees and employers, as well as insurers. Some of the benefits provided to employees include: lower insurance premiums, tax savings, plan portability, and higher contribution limits. Benefits from HSA accounts also accrue to employers and insurance companies through lower premiums and lower benefit payments. Benefits to Employees Health Savings Accounts can provide significant benefits to employees as they are looking into their future health care costs. These accounts, although they are coupled with high deductible health plans (HDHPs) can provide significant savings to employees. Individuals that do not spend a significant amount on health care each year or are early in their careers and have low deductible plans may want to consider increasing their deductibles, lowering their premiums and taking those premium savings and putting them into a health savings account. On average, most individuals spend more money on health care expenses as they get older, so the savings incurred in an employee s early years from participating in an HDHP can be used to help offset future medical expenses. These savings can be invested in a health savings account and be used to cover or offset future medical expenses in the present or in future years. Health care savings accounts also provide employees with a tax savings benefit by allowing them to use pre-tax dollars to invest in health savings accounts. Employees can also put these dollars to work for them by investing them in interest bearing accounts that generate additional income for their future health care costs. Many banks and mutual fund companies have created health savings accounts that can be set up by employers on behalf of employees or by employees themselves. For a small annual fee, usually between $45 and $55, these banks and mutual fund companies will manage HSA accounts on an individual s behalf and provide them income in the form of interest in money market accounts, or dividends and capital gains for HSA accounts that are invested in mutual funds. These health savings accounts are also preferential to flexible spending arrangements (FSAs) in that they permit higher contribution amounts than an FSA. For health plans beginning after Dec. 2012, the maximum contribution permissible for an FSA is $2,500, however for calendar year 2013 contribution amounts for HSAs were limited to $3,250 for employees with single coverage insurance, and $6,450 for family 5 Department of the Treasury, Internal Revenue Service, Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, p. 16.

5 coverage. For 2014, HSA limits will be increased to $3,300 for individuals with single coverage insurance and $6,500 for family coverage. There are no contribution limit increases scheduled for 2014 for FSAs. Another significant advantage of HSAs over FSAs is that HSAs are governed under a use it or keep it philosophy whereas FSAs are created as use it or lose it accounts. As a result, individuals covered under an FSA must be able to estimate their costs for the year and schedule payroll deductions totaling this annual amount. Individuals covered under an HSA can adjust their payroll deductions throughout the year as long as they do not exceed the annual limit permissible by IRS regulations. One final benefit an HSA provides to individuals over an FSA is portability. That is, an HSA is portable and can be transferred from employer to employer provided both employers have high deductible health plans (HDHPs). An FSA however cannot be transported to another employer. A balance remaining in an employee s FSA will be forfeited upon the employee s termination. Benefits to Employers The benefits of HSAs do not only accrue to employees, employers may see benefits through additional cost savings for lower insurance premium payments. By shifting from a Preferred Provider Organization (PPO) health plan to an HSA plan employers may see significant reductions in their health insurance premiums. These premium reductions are a result of the higher deductibles that are assumed by the insured. Therefore employers will see thousands of dollars of savings per employee through lower premium payments. Employers that cover a portion of employee s healthcare expenses may reduce their overall costs by retaining these savings, or taking all or a portion of these savings and contributing to an employee s HSA, or dividing these savings between the employer and employee based on their relative percentage of contribution to premium payments. Employers may also couple their Preferred Provider Organization (PPO) coverage with HSAs. This combination provides an employee with the same network contracted rate of PPO coverage with a higher deductible permitting the employee to contribute to an HSA. Conclusion As employees and employers continually look to weather the ever increasing cost of health care they have many options to consider. One option often overlooked is the adoption of an HSA, which provides employers and employees a significant amount of savings through reductions in premiums and tax benefits. This plan also has the benefit of portability i.e. employees may retain these accounts as they move to different employers. In addition the dollars in this account can be rolled over from year to year thus providing savings in the current year for future medical and health care expenses.

6 Although an HSA is not the panacea for all employers and employees, it is an additional option that should be considered as part of the portfolio of options available. Employers and employees should give careful consideration to all options available in the health care benefits arena to determine which option suits their needs the best.