Health Savings Accounts (HSA)

Prepared By David M. Robinson

The purpose of a health savings account is to provide employees with a portable investment account that employees can own for health care.  To put it another way, a health savings account is a financial security
blanket that an employee can take with him/her from one job to another.

I.                    What is a Health Savings Account (HSA)?

A.     The health savings accounts came into existence when the ‘Medicare Prescription Drug, Improvement, and Modernization Act’ was signed into law by President Bush on December 8, 2003.  This new law created HSAs effective January 1, 2004.

B.     The purpose behind this law is to help American families get the health care they need at a
price they can afford.  By creating a tax-deferred account that is portable and can be used
for medical costs beyond retirement. 

C.     HSAs are tax-free savings accounts that can be used to pay medical expenses incurred by individuals, spouses, or dependents.

D.     These tax-free accounts are designed to help individuals save for qualified health expenses
that they, their spouse, or their dependent(s) incur.

1.      Commonly compared to an IRA account, one can save money in the account for
future medical expenses and grow the account through investment earnings. 

2.      Account balances carry over from year to year.

3.      Interest accrues on a tax-free basis in qualified HSAs. 

II.                 Who is eligible?

A.     In order to be eligible for a health savings account one has to be:

              1.    Covered by a high deductible health insurance plan.

  2.    Not enrolled in Medicare.

3.        Have no other first-dollar medical coverage (other types of insurance like specific
injury insurance or accident, disability, dental care, vision care, or long-term care insurance are permitted).

B.     Even if the employees domestic partner is covered under the HDHP the current tax code and
the Defense of Marriage Act do not allow domestic partners the same benefits as spouses
(Since non-taxable HSA distributions must be for the HSA owner, the owner’s spouse, and/or dependents, medical expenses for a domestic partner are not considered qualified medical expenses).

III.               Who controls the HSA?

A.     All decisions about an HSA account are made by the account holder, these include:

1.      How much money is deposited into the account.

2.      Whether to save the account for future expenses or pay current medical
expenses.

3.      Which medical expenses to pay from the account.

4.      Which company will hold the account.

5.      Whether to invest any of the money in the account, these include choices of
account investment vehicles.

B.     Funds remain in the account from year to year, just like an IRA.

C.     There are no “use it or lose it” rules for HSAs (as is the case for flex spending accounts). 

IV.              What happens to HSAs when the employees status changes?

A.     HSAs are portable accounts employees can carry with them when they:

1.      Change jobs.

2.      Change medical coverage.

3.      Become unemployed.

4.      Move to another state.

5.      Change marital status.

V.                 Who contributes to HSAs?

A.     The individual or family can make tax-deductible contributions to the HSA even if they do
not itemize deductions.

B.     The individual’s employer can make contributions that are not taxed to either the employer
or the employee.

C.     Employers sponsoring cafeteria plans can allow employees to contribute untaxed salary through salary reduction.

D.     To encourage saving for health expenses after retirement, individuals age 55 and older are allowed to make additional catch up contributions.

E.      Once an individual enrolls in Medicare they are no longer eligible to contribute to their HSA.

F.      An employee may also contribute to their HSA through payroll deduction.

VI.              When can HSAs be used?

A.     Distributions from the HSA are not taxable income if they are used to pay for qualified
medical expenses.  Qualified medical expenses include:

1.      Out-of-pocket costs for services covered by the employees high-deductible health
plan (such as office visits and hospital services).

2.      Prescription medications.

3.      Vision expenses (eyeglasses and contact lenses).

4.      Non-cosmetic dental expenses.

B.     Once the employee reaches age 65, they may use their account for non-medical expenses
without penalty; however, the amounts withdrawn will be considered taxable income.

C.     Employees under age 65 that use their HSAs for anything other than qualified medical
expenses must pay income tax plus a 10% penalty on the amount withdrawn.

VII.            What are the employee’s HSA limits and contributions?

A.     Contributions may be made incrementally or in one lump sum.  However, for each month
covered under a high-deductible health plan, contributions can’t exceed 1/12^th of the annual deductible amount or the maximum limit set by the IRS ($2,700 for single-only coverage or $5,450 for family coverage in 2006).

B.     If the employee deposits the maximum annual contribution at the start of the year and
terminates the HDHP coverage midway through the year, then the employee will exceed the maximum allowable contribution.

C.     Individual maximum contributions for 2006 is limited to the employee’s medical plan
deductible or $2,700, whichever is less.

D.     For families with two or more members covered, the maximum contribution for 2006 is
limited to the employee’s medical plan deductible or $5,450, whichever is less.

E.      The maximum contribution amount is indexed for inflation and will likely increase over time. 

F.      There are no minimum contribution amounts, however, most banks require a minimum
deposit to set up HSAs.

VIII.         What happens to HSAs when the employee is deceased?

A.     If married, the spouse becomes the owner of the account and can use it as if it were |their own HSA.

B.     If not married, the account will no longer be treated as an HSA upon death.  The account
will pass to a beneficiary or become part of the estate (and be subject to applicable taxes).

IX.              Where can employees open up an HSA?

A.     Banks, credit unions, insurance companies and other financial institutions are permitted to be trustees or custodians of these accounts.

B.     Other financial institutions that handle IRAs or Archer MSAs (Medical Savings Accounts) are
also automatically qualified to establish HSAs. 

X.                 Examples of HSA participants:

A.     Regional

1.      Higher Education Institutions:

-University of California—Reviewing

-Stanford University*

2.      States that have adopted HSAs for state employees:

-Colorado*

-Utah (HB 76, adopted on 3/17/2006)

-Washington (HB 1383, adopted on 3/29/2006)

B.     National

1.      Higher Education Institutions:

-Yale*

-Northwestern University*

-University of Kentucky*

-University of Minnesota*

2.      States that have adopted HSAs for state employees:

-Arkansas*

-Florida (HB 811 and SB 424, adopted 6/1/2005)

-Indiana*

-Kansas*

-Kentucky (HB 401, adopted 2/21/2006)

-Ohio (HB 46, adopted 5/16/2006)

-Oklahoma (SB 896, adopted 3/15/2005)

-South Carolina*

3.      States that have introduced legislation that would allow HSAs for state employees:

-Alaska

-California

-Iowa

-Michigan

-Minnesota

-Ohio

-New Hampshire

-Rhode Island

-Virginia

-Wisconsin

*Institutions or states that have adopted HSA’s but no record has yet been found of the bill or the adoption date.