Health Savings Accounts
Health Savings Accounts are a new entity in tax year 2004.
In many ways, they are similar to IRA accounts in their tax treatment.
Correspondingly, they are attractive to the same type of people who derive
benefit from an IRA account, predominately individuals with self-employment
income that own private heatlh insurance.
In order to become eligible for a Health Savings Account
(HSA), the individual must obtain a qualified, high-deductable health
insurance policy. Many underwiters of health insurance offer HSA eligible
health insurance. Often the individual can convert from the traditional
health insurance policy (usually with a lower deductable of $250-500,
for example) to a high-deductable policy (with a deductable of $1000-5000)
without a repeat medical examination. It may be as simple of submitting
a form requesting the change.
Switching to a high deductable policy results in a lower
insurance premium. It is this reduction of premium that provides the "cash" to
fund a HSA. Usually, the amount of premium saved is more than adequate
to offset the increased deductable.
For example, a 55 year old individual with hypertension
and hypercholesterol may pay $480/month for a $500 deductable private
health insurance policy. By switching to a $2,400/year deductable policy
from the same company, the premium savings are approximately $200/month.
This generates $2,400 in extra savings ($200 x 12 months) which is used
to fund the HSA.
HSA's generate benefit to their owners in several ways:
-
Generate the functional equivalent of a partial "refund" of
health insurance premiums in all tax years in which the individuals
medical expenses are less than the insurance policy's high deductable.
Using the example above, if annual medical
expenses are $700, then at the end of the year, $700 is removed from
the HSA, leaving $2,400 minus $700 = $1,700 remaining in the HSA.
This money is owned by the individual. It remains in the HSA until
it can be withdrawn to pay for other medical expenses in future years.
This is essentially equivalent to a "premium refund of $1700" as
a result of underutilizing the health insurance benefits.
-
Cost no more than ordinary health insurance during years where the
individuals medical expenses exceed the policy deductable.
If annual medical costs exceed the deductable,
then the funds set aside in the HSA thru premium savings are applied
to the additional out of pocket expenses resulting from the higher
deductable. However, the individual pays no more than he would have
anyway had he retained his original low deductable health insurance
policy. Therefore, you never "loose" if you have
high medical expenses in any given year, but you "win" in any
year your medical expenses are less than your high deductable.
-
Make a wider range of expenses tax deductable as medical expenses,
without requiring a minimum floor be reached (7.5% of Adjusted
Gross Income). That is, all medical expenses are deductable, and
not only the ones that would have been covered by the insurance policy.
Examples of expenses not normally covered by medical insurance are
dental expenses, plastic surgery, and over the counter medication.
A complete list of qualified expenses can be found here. A
list of non-qualified expenses is here.
-
All deposits into the HSA are tax deductable. The higher the marginal
tax rate, the greater the benefit. However, even those with low marginal
tax rates benefit, thru the functional "partial refund" of premiums,
as described in item 1 above.
-
Money left in the HSA may be invested in a wide range of mutual funds,
and grows tax deferred.
-
No taxes are paid on any HSA withdrawals to pay
medical expenses.
-
Ordinary income tax is paid on money withdrawn
for non-medical expenses after the age of 65.
- HSA withdrawals for non medical expenses prior
to age 65 are penalized
10%.
Frequently Asked Questions
What are Typical Savings Using HSA's?
Sample scenarios are provided by:
What deductions are allowed?
What deductions are not allowed?
Who offers Health Savings Accounts?
Some of the banks with the longest experience offering
HSA's:
If you study the web sites of these banks, there are significant
differences between the amount of information available about HSA's,
the user friendliness of the site, the tax forms that can be downloaded,
and the selection of investment choices for HSA funds.
Of the banks in the above list, two stand out for having
a well designed web site with user-friendly online registration, much
information about HSA's and a good selection of mutual funds available
to invest account funds:
Fees charged by all of these banks are similar. Costs are
approximately $30/year, $30 to open an account, and 1/8% per quarter
for any funds invested in mutual funds. Most offer check writing and
debit cards associated with these accounts, either for free or for slightly
extra fees. Additional information representative of typical fees charged
is available from:
Here are some user-friendly enrollment forms
offered by:
HSA Bank offers the largest selection of mutual funds,
which include Mutual
Series, Schwab, T. Rowe Price, and Matthews Asian Funds:
Health Savings Administrators LLC offers a selection of
Vanguard funds:
Should Those in Low Marginal Tax Brackets Consider an HSA?
Yes. Even disregarding the tax deductions generated and
the tax deferred growth of funds in the account, every year that medical
expenses are less than the high deductable, there is additional money
that accumulates in the HSA and remains the property of the owner. Essentially,
in each of these years, the individual has essentially received a partial
refund of insurance premiums for underutilizing the health care system.
Does the HSA have to be funded each year?
No. Each year, the HSA should be funded with at least the
amount of the prior year's out of pocket medical expenses. This degree
of funding is required to capture the "tax deduction" of these medical
expenses. Additional amounts of funding beyond this amount are descretionary
and should be considered by those who wish to have "additional" IRA type
funds growing tax deferred. However, these additional funds are not required
to capture a major benefit of HSA's, namely, the effective partial reimbursement
of insurance premiums in years where medical expenses fall below the
deductable.
In fact, very little money need be "tied up" in the HSA at
all. For example, at the end of the year, the individual totals up the
year's medical expenses. Before April 15th, the individual funds the
HSA with at least this amount to cover prior year's medical expenses.
Immediately after funding the HSA, the individual can then request a
withdrawal from the HSA to reimbursement himself for medical expenses
of the prior year. Thus, the money only has to be in the account a very
short while. For individuals who do not wish to invest their funds in
mutual funds, keeping a "minimal" balance
in the account can be considered.
What tax forms are required?
The bank holding the HSA will issue a tax form annually
showing the total withdrawals from the account. The individual must keep
records showing that these withdrawals were used to pay legitamate medical
expenses, in the event of an audit. The "details" of the individual expenses
are NOT required to be reported on tax returns. Therefore, tax compliance
is relatively trivial.
Information on the tax filings required may be found at:
How much may an individual contribute annually to an HSA?
What deductable is ideal for an HSA?
The savings in insurance premium resulting from increasing the deductable,
should be enough to accumulate the amount of the deductable in one year.
If you choose too high a deductable, and the premium savings do now allow
the accumulation of enough funds in the HSA to match the deductable,
then in the event of high medical expenses for several years in a row,
the individual would not
"cover" all of his out of pocket medical expenses throught
he savings generated by the lower premiums.
By keeping the deductable no higher than can be funded in a single year
of "premium savings", the individual does not risk the possibility of
increased out of pocket expenses, compared to his existing non-HSA private
health insurance. He therefore places himself in a no loss - possible
win situation each year.
Should Employers Consider HSA's for their employees?
YES. Often, employers that offer health insurance take a Section 125
deduction for this expense, taking the insurance costs out of the
payroll total. This does not generate a substantial additional
tax benefit to the employer, in itself, since all medical insurance expenses
paid would be deductable anyway. However, by thereby reducing the "total
payroll",
the employer is able to reduce his expenses for Workman's Compensation
insurance, which IS tied to the total payroll.
Also, the employee benefits by having additional funds accumulating
in their segregated HSA's each year that their medical expenses fall
below the high deductable. This essentially creates a separate IRA-like
retirement account for employees. Thus, the employer is able to offer
a greater benefit package to his employees, and thereby may be able to
reduce the necessary salary paid to retain desirable employees.
More information about HSA's for employees is available from:
How do HSA's compare with MSA's and HRA's?
Where can I find additional information on HSA's?
Where can I find a summary of the most recent changes in the HSA program for 2006?
The Tax Relief and Health Care Act of 2006 (H.R. 6111) has been signed by President Bush. This legislation enhances the future use of Health Savings Accounts (HSAs) to fund our health care. The full HSA text of the bill can be found at:
The intent of this bill is to increase utilization of HSAs. The following link provides an easy to understand chart of the changes:
Note that the HSA contribution limit is no longer tied to the deductible. You can now contribute to your HSA up to the annual maximum limit which for 2007 is $2,850 for single and $5,650 for family. This change increases a subscriber's monthly maximum contribution to $237.50 for single coverage and $470.83 for family coverage.
Additional information about Health Savings Accounts is available from the US Department of Treasury website:
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