As part of the Medicare Prescription Drug Improvement and Modernization Act of 2003 there was a provision that created a new type of tax-favored account called a health savings account or H.S.A.

Individuals that are covered under a high deductible health plan can use this tax-favored account to pay for certain medical expenses.

Who is eligible?

Any individual, under the age of 65, 

• who is covered by a high deductible health insurance policy

• who is not covered by another health plan, such as an employer-provided health plan

• or, who is not claimed as a dependent on another person’s tax return.

What is a High Deductible Health Plan or HDHP?

An HDHP is a health insurance policy

• with an annual deductible of at least $1,100 for self-only coverage and

• at least a $2,200 deductible for family coverage

• For 2008 the maximum out-of-pocket expenses (i.e., deductibles, co-payments, and other amounts besides premiums) must be no more than $5,600 in the case of self-only coverage

• and $11,200 in the case of family coverage.

Note that the deductible and out-of-pocket amounts are indexed for inflation.

    In the case of a health plan that uses a “physician network” the annual deductible for services that are provided outside this network are disregarded and the annual out-of-pocket limitation for such expenses will not cause the plan to fail to be treated as an HDHP.

How is the Contribution Tax-Favored? 

    Contributions of an H.S.A. are excludable from gross income and from wages for employment tax purposes. 

    If an employer makes H.S.A. contributions, the employer must make available comparable contributions on behalf of all “comparable participating employees” during the same period. 

    The legislation also provided that H.S.A.’s can be offered under a cafeteria plan. Thus, they may be funded with pre-tax salary reductions and/or flex credits.  

How much can you contribute to an H.S.A.?  

The maximum annual contribution is the lesser of 100% of the annual deductible under the HDHP or an indexed amount.  

    For 2008 the amount is $2,900 for self-only coverage and $5,800 for family coverage.  

Does each family member have to meet a deductible? 

    No. All contributions to the deductible are aggregated for purposes of applying the limit.  

What if I already have a Medical Savings Account or Archer MSA? 

    Any contributions to an MSA will reduce the annual H.S.A. contribution limit (i.e., no double dipping). 

    You are allowed to rollover from one H.S.A. to another or from an Archer MSA. Such rollovers are not subject to the annual contribution limits!  

Where can H.S.A. contributions reside? 

    Contributions to an H.S.A. account are treated as a tax-exempt trust. 

The trustee can be a bank, an insurance company, or a third-party administrator or TPA that is licensed and bonded.  

Can the funds in my H.S.A be invested where I see fit? 

Yes. They may be invested in  money market funds, mutual funds, etc, except they may not be invested in life insurance contracts. And, again, the earnings on the accounts build-up free of taxes.  

How are distributions from the H.S.A. treated? 

    Distributions from an H.S.A. are not includible in gross income if used to pay for “qualified” medical expenses.  

What are Qualified Medical Expenses? 

    Such expenses may include dental, vision, chiropractic care and alternative medicine. Generally, they are defined as costs incurred to diagnose, cure, treat or prevent a disease. In Fact, preventive services may be covered on a first-dollar basis, and deductibles will not apply. For a specific list you can order publication 502 from the IRS or contact us.  

Can a distribution be used to pay for health insurance premiums? 

    A distribution can be made for COBRA premiums, Medicare premiums (but not Medigap), retiree health coverage, and health insurance premiums for those receiving unemployment benefits.  

What if they are not used for qualified medical expenses?  

    The distributions will be includible in your gross income and are subject to an additional 10% tax, except in the case of distributions made after the account beneficiary’s death, or attainment of the age of Medicare eligibility.  

How does an H.S.A. compare to a Flexible Spending Account under a Cafeteria Plan?  

They may be an attractive alternative to an FSA as they are not subject to the “use-it-or-lose-it” rule. Any unused funds carry over from year to year, and it’s portable!  

When does the deductible apply under the HDHP in relation to the H.S.A.?          The I.R.S. recently filed a Notice clarifying that for individuals with family coverage, no amounts can be paid from the HDHP (other than for exempt preventive care) until the entire family deductible has been satisfied except for preventive care.   

When do I make my H.S.A. contribution?

    H.S.A. contributions may be made monthly or in one lump sum, such as, at time of claim.  

What are some of the other conditions for an employer who wants to offer an H.S.A.?  

·        An H.S.A. can be offered in conjunction with a section 125(d) cafeteria plan.  

·        A self-insured medical reimbursement plan can be considered an HDHP!  

·        There is no limit on employer size or total enrollment.  

·        There is no longer a sunset provision as was under an MSA.  

·        Contributions may be made by any combination of employer and employee.  

·        Employers may find with the resulting lower premiums from the higher deductible

plans that the premium savings can be contributed to the H.S.A. This in turn can be supplemented with the worker’s own tax-deductible contribution  

·        Any H.S.A. contribution from the employer has to be paid up front for all of the participating employees, whether they are using services or not.  

Other points of interest:  

·        A taxpayer does not have to itemize deductions in order to take the contribution as a deduction.  

·        An H.S.A. will provide people with a tax-favored way of paying for the out-of-pocket costs they are already incurring on an after-tax basis.  

·        An H.S.A. will cause a dynamic effect as costs become more visible to consumers, and they begin to force the industry to develop more attractive pricing.  

·        Administrative costs for providers will be lower, especially for physicians, as most services will be paid at the time of service.  

·        The H.S.A. funds will not just be used to pay for retiree health care or to supplement a retiree’s income when they are no longer able to work, but they will be available to help pay for long-term care needs. This is something no other plan is doing anything about.