Health Savings Accounts

1. Health Savings Accounts An Overview of the Rules and Open Issues February 2004

2. Health Savings Accounts • Tax-free accounts combined with high deductible health plan (HDHP) • Minimum HDHP deductible: $1,000 individual/$2,000 family • Employee and employer contributions • Tax-free distributions for qualified medical expenses • Accounts are fully portable • Effective January 1, 2004

3. Who Can Set Up an HSA? • An individual or an employer • Eligible individual: • Covered by HDHP • Not covered by another health plan • Not eligible to be claimed as a dependent • Not eligible for Medicare • Funds managed by trustee or custodian

4. What is a HDHP? • Annual deductible of at least $1,000 • May not have total annual out-of-pocket expenditures in excess of $5,000 • Both are doubled for family coverage • May provide first dollar coverage for preventative care

5. Network Plans • A plan may have different in-network and out-of-network benefits • A network HDHP may require charges for services provided outside of the network that exceed the annual out-of-pocket limit • The annual deductible for out-of-network services is not taken into account in determining the annual contribution limits

6. Other Permitted Insurance • General rule: the individual must be enrolled in only a HDHP • Exception for Permitted Insurance: • Worker’s Compensation • Coverage for tort liabilities • Coverage for property (e.g., car or homeowners) • Specified disease or illness policies • Insurance paying a fixed amount for hospitalization • Coverage for accidents or disability • Dental, vision, or long-term care coverage

7. Contribution Limits • Individuals, their family members, and employers may contribute • Contributions must be in cash • 2004 contribution limits are the lesser of: • 100% of the deductible for the HDHP, or • $2600 for self-only, $5150 for family (indexed for inflation)

8. Contribution Limits (Cont.) • Catch-up contributions are allowed between ages 55 and 65 • $500 per year in 2004 • Increases $100 per year until the amount reaches $1000 in 2009 • MSA balances may be rolled over

9. Qualified Medical Expenses • Internal Revenue Code Section 213(d) • May not be used for insurance premiums, except the following: • COBRA • Health coverage while the individual is receiving unemployment compensation • Health insurance (other than Medicare Supplement coverage) for individuals age 65 and over • Qualified long-term care insurance

10. Tax Treatment: Individual Contribution • HSAs may be offered through a cafeteria plan • Employee contributions made through salary reduction • Pre-tax contributions • For an individual HSA, the individual may take deduction on their federal income tax return • Above the line deduction • Do not need to itemize

11. Tax Treatment: Employer Contribution • Employer is allowed a deduction • Contribution is excludable from the employee’s gross income and is not subject to withholding from wages for income tax, FICA, or FUTA • Excess employer contributions are subject to a 35% penalty

12. Tax Treatment: Earnings • Earnings on an HSA are not considered income for federal tax purposes

13. Tax Treatment: Excess Contributions • Contributions in excess of the contribution limits are considered income to the individual • The income accrues regardless of who made the contribution • Account holder will be subject to a 6% excise tax on the excess contribution amount • Treasury correction procedures

14. Tax Treatment: Distributions • Qualified distributions for expenses of the individual or family members are excluded from the individual’s gross income • Non-qualified distributions are includible in gross income and subject to a 10% excise tax • Exception after death or disability, or when the individual reaches age 65

15. Do Nondiscrimination Rules Apply? • HSA statue includes a “comparable contribution standard”: an employer must make a comparable contribution available to all eligible individuals • It appears an employer may define who is covered • Internal Revenue Code Section 105(h), which prohibits discrimination in favor of highly compensated employees, does not seem to apply

16. Other Frequently Asked Questions • Are HSAs subject to ERISA? • Can employers impose a vesting schedule? • If an employee sets up an HSA separate from the employer, can the employer still contribute? • Can HSAs be used to pay for long-term care expenses? • Can employers still establish and/or contribute to MSAs?

17. Open Issues • Timing of final Treasury guidance • Definition of preventive services • Carve out of Rx coverage and or other services from HDHP • Employer matching contributions • Amount of contribution available if health expense exceeds HSA balance • Coordination of HSAs, FSAs, and Health Reimbursement Arrangements (HRAs) • HRA rollovers • Which cafeteria plan rules apply • Possible state tax laws • Reasonable lifetime caps on HDHP

18. Possible Legislative Changes • Use for retiree health premiums • Ability to deduct premiums for HDHPs purchased in the individual market • Federal preemption

19. Questions about HSAs?