When the sweeping new Medicare law was recently signed into law, bundled within it was an unrelated but key provision for employers—the creation of tax-free Health Savings Accounts (HSAs). We’ll explain what HSAs are, who’s eligible, and what they could mean for you and your employees. We’ll also highlight a few potential downsides you should be aware of.
What HSAs Are
HSAs are tax-exempt savings accounts employees can set up to pay medical expenses. HSA funds can be used to cover health insurance deductibles and any co-payments for medical services, prescriptions, or products. They can also be used to buy over-the-counter drugs and long-term care insurance, and to pay COBRA health insurance premiums.
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Who’s Eligible
Starting this calendar year, eligible individuals can establish HSAs if they meet all of these criteria:
- They are covered under a high-deductible health plan (HDHP).
- They are not covered under any plan that is not an HDHP.
- They are not entitled to benefits under Medicare (generally, this means they are under the age of 65).
- No one else can claim them as a dependent on a tax return.
An HDHP has a minimum deductible of $1,000 for self-only coverage, with a $5,000 cap on out-of-pocket expenses. For family coverage, the minimum deductible is $2,000, with a $10,000 cap on out-of-pocket expenses.
Preventive care services and coverage for accidents, disability, dental care, vision care, and longterm care are permitted in addition to an HDHP.
Contributions
The employee, the employer, or both may contribute to an HSA. Family members may also put money into an HSA on behalf of another family member, as long as the other family member is eligible.
The amount that may be contributed each year is calculated by taking the base amounts for individuals and families and adjusting them to reflect the cost of living. For 2004, when you add cost of living to the base amounts of $2,250 for individual coverage and $4,500 for family coverage, $2,600 and $5,150 may be contributed respectively.
Individuals aged 55 to 64 can make additional catch-up contributions. This year the catch-up limit is $500, and it will increase by $100 each year to $1,000 in 2009. A married couple can make two catch-up contributions if both are at least 55 years old.
Tax Status And Penalties
Employer contributions to an employee’s HSA are not included in the employee’s taxable income. Contributions made by employers, employees, and family members are tax-deductible, even if the account beneficiary does not itemize. Also, interest and investment earnings generated by the account are not taxable while in the HSA.
HSA money used for qualified medical expenses is not taxable, but money taken out for nonmedical expenses is subject to income tax, plus an additional 10 percent penalty. This penalty is waived for death, disability, and nonmedical distributions made by individuals age 65 and over.
The Pros
- Fewer limitations. HSAs bypass many of the limitations of other taxexempt medical savings arrangements. For example, while Medical Savings Accounts are available to small companies and the selfemployed only, HSAs are available to employers of all sizes. Money in HSAs rolls over from year to year, unlike the funds in “use it or lose it” Flexible Spending Accounts. And unlike Health Reimbursement Accounts, HSAs can be funded by both employees and employers.
- Flexibility. HSAs offer employers flexibility and potential cost savings. A self-insured medical reimbursement plan sponsored by an employer can be an HDHP, and you can offer HSAs through a cafeteria plan.
- Lower premiums. The high-deductible requirement means that both you and your employees pay lower insurance premiums.
The Cons
- Portability. Employees who leave will take your contributions with them.
- Potential cost-shifting. The high-deductible requirement may make HSAs particularly attractive to the wealthy (who can afford the deductible) and the healthy (who feel they won’t need to pay it). If these employees abandon traditional plans in droves, they may drive up premiums for employees who cannot make the switch. This, in turn, will raise your costs.
- Antidiscrimination laws. Employer contributions to HSAs are subject to the antidiscrimination laws. This means you must make comparable contributions on behalf of all eligible employees, unless you offer the HSA as part of a cafeteria plan.
- Insurer delay. It may take insurance carriers a while to develop HSA-compatible packages, although some have already done so, including Aetna and UnitedHealthGroup.
Bottom Line
HSAs are a promising addition to the health benefits lineup for both employers and employees. We’ll keep you posted about ongoing developments.