HEALTH SAVINGS ACCOUNTS (HSAs)

The days of the "high-option, zero-deductible, first-dollar" health insurance plan are over. Health Savings Accounts are the principal weapon in the fight against rising health care costs. HSAs will build a more consumer-driven market for health services.

The Medicare Prescription Drug, Improvement, and Modernization Act signed by President Bush on December 8, 2003, created the Health Savings Account (HSA) system and THE EMPLOYERS COUNCIL is convinced that with the cost savings and generous tax-treatment of HSAs, more and employers will offer them to their employees!

These tax-free accounts are designed to help people save for qualified health expenses. A person who is covered by a high deductible health plan can make a tax-deductible contribution (up to $2,000 a year) to an HSA, and use it to pay for out-of-pocket medical expenses. This will help more families get the health care they need at a price they can afford. The annual deductible must be at least $1,000 for single coverage, and at least $2,000 for family coverage.

Contributions to HSAs are tax-deductible, even if the taxpayer does not itemize. Contributions by an employer are not included in an employee's taxable income. The interest and investment earnings generated by the account are also not taxable while they remain in the HSA.

Money taken out of an HSA is not taxable -- as long as it is used to pay for qualified medical expenses. (A 10% penalty applies to non-health withdrawals.) HSA money can be used to cover the health insurance deductible and co-payments for medical services, prescriptions or products. The money can be used to purchase over-the-counter drugs and long-term care insurance, and to pay health insurance premiums during any period of unemployment. Any money not used stays in the account, rolls over each year and continues to earn interest on a tax-favored basis to supplement retirement, just like an IRA.

HSAs are portable. They are owned by the employee, not the employer. If the employee changes jobs, the HSA goes with them. Setting up your program will take time and will require your HR staff and first-level supervisors to be knowledgeable about this benefit. Employees will need to be educated about being "smart shoppers" for health services -- you’ll have to help them find the best deals for lab tests, drugs, specialist care.

When employees see the real costs of their health care decisions, they’ll be able to avoid over-priced, inefficient health care providers and there will be some much needed competition in the health business. HSAs are not a panacea -- but we believe they will restore a high degree of freedom of choice without the extensive restrictions imposed by traditional health plans.

The idea behind HSAs is simple: people will curb their health care spending if they get to benefit from the savings .. placing downward pressure on medical costs. People cannot contribute to an HSA if they are covered by a plan that has certain deductibles. If they are not covered by a plan like this, they can contribute to the lesser of the annual deductible on their plan ($1,000 is the maximum or $2,650 for self-only coverage).

What happens when one spouse has an employer-sponsored plan with deductibles that are too low for an HSA and the other spouse is not covered, or opts out.  The Treasury has recently ruled that these spouses can set up an HSA is they have a high-deductible...even is the spouses plan covered the couple's children.   

THE BASICS: Here's how an HSA works -- take the money currently spent on a high cost traditional health plan and split it like this: Put a portion towards a low cost higher deductible policy and deposit the balance into a tax-deductible HSA.

The accounts (can be stocks, bonds, mutual funds) must be used to help pay smaller covered medical expenses until the deductible is met; if the need arise, the high deductible insurance policy takes care of covered medical expenses that exceed the deductible.

When Congress originally designed the MSA law back in 1996, it did so with the idea that each person or family funding a savings account for medical expenses should always be required to carry insurance as a back-up in the event a "catastrophic" type of medical situation were to arise. This was a prudent requirement; otherwise, some people would be under the mistaken impression that they could "save" their way to financial freedom from the high cost of health insurance.

The insurance policy -- required under the law -- is by its nature a "catastrophic" type of coverage. It requires a "high deductible" and allows no "co-pays" to be included in the coverage (at least not until the deductible has been satisfied).

This does not mean that the actual insurance policy only covers "big expenses," (those incurred in the hospital). In general, most of the HSA-qualified policies are actually comprehensive major medical policies that just happen to have a "high deductible" to satisfy the HSA federal law mandates. The HSA law actually allows for some preventative type of expenses to be covered not subject to the deductible.

The size of the deductible depends on the number of people actually being insured. If there is only one person to be insured (an adult) then it is classified as a "single" plan (even if the person is married). If the policy covers two or more people, it is classified as a "family" plan. With both the single and family plans, there is a minimum and a maximum deductible amount established by Congress.

Here are the HSA numbers for the tax year 2004:

                                        Minimum Deductible                         Maximum Deductible

Single Plan                                   1,000                                                2,550

Family Plan                                  2,000                                                 5,150

With the HSA law, the "maximum out-of-pocket" amounts have been substantially increased. For singles, it is $5,000 and for family plans it is $10,000 (indexed for future inflation). This can be a source of needless confusion. The "out-of-pocket" maximum is simply a combination of the deductible PLUS any "co-insurance" AFTER the deductible.

Example: Family plan with $5,100 deductible that pays 80/20 of the next $5,000 AFTER the deductible would have a total out-of-pocket of $6,100 in covered expenses (20% of the next 5,000 in covered expenses is $1,000 PLUS the $5,100 deductible) . Remember, only covered expenses count toward the deductible AND co-insurance.

IMPORTANT: Only the deductible amount is factored in when determining the maximum HSA contribution for the year. For this reason, it may not make a lot of sense to substantially increase the out-of-pocket maximum too much beyond the deductible -- unless there is a significant reduction in premiums!

One of the most popular plans on the market actually offers a "50/50" co-insurance option. It's popular because it offers significant reductions in premiums while still limiting the total out-of-pocket to a reasonable amount, typically between $800 (single) and $1,200 (family) beyond the deductible.

With the family plan HSA policy, the deductible takes on a special feature—it is a per family deductible, and not "per person". Almost without exception, every other policy on the market covering a family has a deductible "per person" so the HSA plan deductible feature truly is unique -- and required by law (this is one main reason why not just any "high deductible" insurance policy qualifies as an HSA-approved policy). With a "per family" deductible, covered expenses incurred by each person accumulates and is credited toward the one "family" deductible.

Some people believe that because there is no "co-pay" that the doctor visits and prescription drugs are "not covered". This is incorrect -- at least with most HSA-qualified policies. There are a FEW policies that allow people to "carve-out" certain out-patient expenses, such as prescription drugs.

With most HSA-qualified policies, doctor visits and prescriptions are "covered," -- they are just not reimbursable until the deductible is satisfied for the year. Only covered expenses accumulate toward the deductible so it is important that the HSA account holder knows what expenses are actually covered under the insurance contract.

Other covered expenses generally include the same covered expenses you would expect to be covered under a high-quality comprehensive major medical policy, including but not limited to, physician’s services in and out of the hospital, diagnostic testing in and out of the hospital, hospital charges, surgical expenses, transplants and so forth.

Of course, exclusions and limitations apply. For instance, dental and vision expenses are typically not covered under the insurance policy (but are allowable expenses for tax-free withdrawals from the savings account).

Not every HSA-qualified policy offered in the market place is the same! Buyers should compare, line-by-line, the numerous benefits, exclusions, and limitations of each policy.

Unless an employee is applying for employer-sponsored coverage, (group insurance) the insurance policy will be an individually underwritten policy. As such, issuance of coverage is subject to underwriting on a case-by-case basis. Premiums and ultimate offers are determined by the age, sex, location, and health factors of each person or family to be insured -- just as with any other "individually underwritten" coverage. Coverage for certain conditions may be excluded or modified, a higher premium may be charged, or coverage could be completely denied.

Usually, there is no physical exam required, but each company reserves the right to request a physical exam (typically a "paramed" exam) if they feel it necessary as a prerequisite to assessing the risk. In most cases, underwriting consists simply of the completion of an application being forwarded to the company for review.

Insurance companies are taking a hard-line approach to keeping future expenses in line. Most "pre-existing" conditions will be "ridered"-out, or excluded, from coverage, at least for a minimum period of time. Example: Existing hernia -- will likely get an exclusionary rider.

Use this handy worksheet to see how an HSA will benefit you financially.

Traditional Plan

STEP 1 Enter current insurance premiums (annual) __________

STEP 2 Subtract annual tax-savings:

Premium deduction (100% for self-employed) __________ (premium x 100% x tax rate)

HSA contribution - 0 -

STEP 3 SUB-TOTAL Annual Expense __________

STEP 4: Add any additional out-of-pocket expenses, such as deductibles, co-pays, co-insurance, and expenses not covered by insurance to arrive at a NET Annual Cost: __________

HSA-Qualified Plan

STEP 1 Enter HSA-Qualified Health Plan Premium __________

STEP 2 Subtract annual tax-savings:

Premium deduction (100% for self-employed) __________ (premium x 100% x tax rate)

HSA contribution (100% of amount contributed) __________ (deposits x tax rate)

STEP 3 NET Annual Cost* __________

*From this total, do not add expenses paid directly out of the HSA savings account. With an HSA, you are saving dollars to use for future medical expenses that may, or may not, ever occur. Plus, you are getting a 100% tax-deduction for every dollar saved, regardless of whether those dollars are ever actually needed for medical expenses.

Note: The biggest mistake people make in comparing a traditional plan to an HSA plan is that they mischaracterize money deposited into the HSA savings account. These are dollars truly being saved. The law allows a 100% tax-deduction for each dollar saved.

You are saving in advance for future medical expenses that may never occur, and you are getting an instant, 100% tax deduction for the money deposited into the savings account each year. If $60 is withdrawn to pay a doctor's bill, it is wholly incorrect to characterize that $60 withdrawal as an "extra out-of-pocket" expense that year, in view of the fact that the money has already been set aside for this very purpose -- and you got a 100% tax-deduction in the year in which you originally deposited that money.

EXAMPLE

A working example using Jack & Jill's hypothetical family will help illustrate the math. Their traditional Preferred Provider Organization plan with Acme Ins. Co. costs them $5,400 a year (soon to be raised by over $1,000 per year, but we'll just use the current premium to be more conservative).

Their new HSA-Qualified plan will cost $2,880 in premiums. They plan to deposit only $3,600 into their HSA account.

STEP 1 Current Ins. Premium $5,400

STEP 2 Subtract Tax-Savings: Self-Employed - 1,782 (5,400 x 33% estimated tax-bracket) HSA - 0

STEP 3 Net premium costs $3,618

To this, Jack & Jill would need to add any additional out-of-pocket costs, such as co-pays, co-insurance, deductibles, and expenses not covered by insurance. Let's assume they have a good year, incurring only 6 doctor's visits (retail price $60 each) and one emergency room visit for $500 (which is equal to their policy deductible, by chance). They have a $20 co-pay per Doctor visit and must pay the entire $500 for the emergency room visit.

STEP 4 ADD:

Co-pays $ 120 (6 doctor's visits -- retail cost $60 each = $360)

Deductibles $ 500 (One E.R. visit @ $500)

Total out-of-pocket $ 620

Plus net premium cost + 3,618

TOTAL ANNUAL COST $ 4,280

Compare to HSA-Qualified Plan

STEP 1 HSA Ins. Premium $ 2,880

STEP 2 Subtract Tax-Savings: Self-Employed - 950 (2,880 x 33% estimated tax-bracket) HSA - 1,237 (3,750 x 33% estimated tax-bracket)

STEP 3 Net premium costs $ 693

HSA Account

To receive the $1,237 tax-savings, Jack & Jill have decided to contribute $3,750 to their HSA savings account. Thus, at the beginning of the tax-year, they have a balance of $3,750 in the account (discounting any interest earned). If they incur the same medical expenses as above, those funds will come directly from their HSA account, and not "out of their pockets". It is true that the dollars are no longer in their original pockets, but the money still belongs to Jack & Jill -- it has been saved for future use in a special tax-sheltered savings account. Ordinarily, money must be spent in order to qualify as "out-of-pocket" expenses.

Balance of HSA at end of year $3,750

Less medical expenses incurred $ 860 ($500 E.R. visit and 6 Dr's Visits @ $60 each -- same as above)

Net Balance (Carry-over) $2,890

Bottom line: Jack & Jill have $2,890 left-over after paying all of their health insurance premiums and medical expenses for the year. To this, they will add another $3,750 next year, and the next, etc., each year receiving another 100% tax-deduction for making those contributions.

Of course, when Jack & Jill withdrew the $860 to pay their medical expenses for the year, there was no withdrawal penalty and no-taxes due on those dollars under the HSA program. Additionally, since they receive about $1,237 each year in tax-savings, they are correct in stating that the $860 was actually money that would have gone to Uncle Sam in taxes anyway, if they had not established an HSA. Thus, the government has effectively subsidized Jack & Jill's medical expenses for the year!

It is also worth noting that if Jack & Jill had experienced a really good year and incurred no medical expenses, their net healthcare costs would have been $3,618 (net premium cost under traditional plan) compared to $693 (net premium cost under the HSA plan). Plus, they would have s-a-v-e-d $3,750 to use for future medical expenses, money which will help them at retirement if it is not needed toward medical bills along the way.

The Treasury Department and the IRS have issued comprehensive guidance on Health Savings Accounts that will help providers to establish HSAs and consumers to enjoy their benefits. The guidance answers questions on a wide range of issues that the public has brought to the Treasury Department since the creation of HSAs. The guidance is in an easy-to-use question and answer format -- is available on-line at: Part III - Administrative, Procedural, and Miscellaneous

This link will take you to the U.S. Treasury Department's website -- the Notice is in  .PDF format. Scroll down to the bottom of that page until you find Notice 2004-50. 

You will need the free Adobe Reader program to view it. Copy the URL (below) and paste it into your browser: http://www.adobe.com/products/acrobat/readstep2.html

Among the items clarified by the guidance are:

• Benefits under Employee Assistance Plans, Disease Management Plans and Wellness Programs generally do not disqualify an otherwise eligible individual from contributing to an HSA.

• Mistaken distributions from an HSA can be repaid to an HSA without penalty or tax.

• Generally, the salary-reduction rules do not apply to HSA salary reduction contributions, which generally follow the more flexible 401(k) type rules that allow changes in elections throughout the year as long as any election is effective prospectively).

• Payments by individuals due to traditional benefit limits that are part of reasonable plan designs do not count against the out-of-pocket maximums.

• Employer matching contributions made through a cafeteria plan are not subject to the comparability requirements.

• Account fees paid from HSAs are nontaxable distributions; account fees paid outside of the HSA directly to trustees are not treated as contributions.

By answering the remaining questions about the rules for HSAs and the required accompanying High Deductible Health Plans, the guidance will assist employers, insurance companies and HSA trustees in designing health plans that incorporate HSAs.

10/8/05