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Before you can begin to advise clients on Health Savings Accounts, it’s important to understand how HSAs and high-deductible health insurance operate. This guide introduces you to HSAs and gives you an excellent description of all the guidance that the federal government has issued on HSAs and high-deductible health insurance plans, including new contribution rules, new safe-harbor conditions, and procedures for correcting excess contributions.
In addition, this comprehensive, well-organized guide gives you information on the law and regulations that focus on:
The Adviser's Guide includes helpful appendices with IRS and Administrative forms, as well as a Groom Comparison of HSAs, FSAs, and HRAs.
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Introduction to Health Savings Accounts (HSAs)
The steadily rising cost of health care and premiums for health coverage in this country presents an economic challenge for many individuals, some of whom struggle to maintain coverage, and others who opt to remain uninsured. Also, employers of all sizes who traditionally have provided health benefits for their workforces have become concerned about their ability to continue to offer such coverage on an affordable basis. This was the climate when, as part of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (MMA) enacted on December 8, 2003, a new type of tax-favored savings vehicle for health expenses known as a Health Savings Account (HSA) was created. Three years later, after HSAs had gained some popularity, Congress made significant improvements. On December 20, 2006, President Bush signed into law the Tax Relief and Health Care Act of 2006 (P.L. 109-432) (TRHCA) which included several significant HSA provisions, such as increases to the contribution limits and administrative simplifications. This chapter provides the history of HSAs (including their establishment, improvement, and regulation), and explores the pros and cons of both participating in an HSA arrangement as an individual and offering an HSA arrangement as an employer.
An HSA, described in Code Section 223, is a funded account, similar to an Individual Retirement Arrangement (IRA). Contributions may be made within specified limits by individuals who meet certain eligibility requirements and/or by employers or others on behalf of such individuals. Amounts in an HSA grow on a taxdeferred basis and, if used for qualified medical expenses, may be distributed on a tax-free basis. In order to contribute to an HSA, an individual must be covered under a High Deductible Health Plan (HDHP) and may not participate in any other non-HDHP, subject to certain exceptions.
Predecessor to the HSA: The Archer Medical Savings Account (Archer MSA)
The HSA is based upon and similar to the Archer MSA (discussed more fully later), which became available in 1996 for use by self-employed individuals and employees of small employers (those with 50 or fewer employees). Archer MSAs, however, have not enjoyed widespread use in large part due to a restriction that prohibits employers with more than 50 employees from making the account available to employees. The Health Insurance Portability and Accountability Act of 1996 (HIPAA) placed a cap on the number of individuals (generally 750,000 taxpayers) who could have an Archer MSA. That number was never reached.1 Also, although Archer MSAs were set up as a temporary program originally due to expire in 2000, Congress extended that deadline four times
Two substantive differences between Archer MSAs and HSAs relate to the deductible under the HDHP and the funding of the account.Archer MSAs have required upper and lower limits on the deductible under the HDHP, but HSAs have only a lower limit.
Archer MSAs are not permitted to be funded by both an employer and employee during the same plan year, or with pre-tax salary reductions through an employer’s cafeteria plan. HSAs may be funded by both the employer and the employee during the same plan year as well as by any other individual on behalf of the employee. HSAs also may be funded through an employer’s cafeteria plan on a pre-tax basis.
HSA – A Consumer-Driven Health Plan
The years immediately preceding the enactment of the MMA were a period during which “consumer-driven” or “defined contribution” health plans emerged, through which employers offered employees a defined amount of health care dollars to be spent or saved for future use, at the employees’ discretion. Proponents tout these alternative arrangements as a way to make costs more predictable and provide incentives to employees to make wiser health care spending decisions. HSAs are consistent with the consumer-driven philosophy. Also, many view HSAs with favor because they provide the ability to use amounts in the account for medical purposes on a tax-advantaged basis as well as for nonmedical purposes (subject to income tax and 10% additional tax). With the exception of Archer MSAs, existing vehicles for providing such coverage on a tax-advantaged basis do not allow that flexibility. Finally, because HSAs are based on Archer MSAs, which had been enacted earlier, there was precedent for the approach.
A Method to Reduce Health Care Spending
To participate in an HSA, an individual must be covered by an HDHP. HSA proponents take the position that participants can save money by participating in an HDHP that generally has lower premiums than a non- HDHP. Also, proponents contend that, if participants are given a choice either to save money in an HSA account (which can earn interest tax-free) or to spend it on medical goods and services, they will confine their spending to only necessary purchases and will demand lower prices, more value for their dollar, or both. In contrast, under traditional health plans, the full cost of a service is not as obvious or important to a participant because he or she typically is responsible only for the copayment. Thus, HSA proponents argue that HSAs will reintroduce market forces to the health care system as well as allow savings to accumulate on a tax-free basis to pay for future health care expenses.
Other Defined Contribution or Consumer-Driven Health Accounts
Health Reimbursement Arrangements (HRAs), Health Care Flexible Spending Arrangements (health FSAs), and Archer MSAs are considered defined contribution or consumer-driven health accounts because they all allow employees to decide how the dollars credited or deposited to their accounts are spent.
All three health account types share a common purpose of making dollars available on a tax-advantaged basis to reimburse medical expenses. However, the way they are required to be structured under federal law differs. The main differences between an HSA, a health FSA, and an HRA include the following:
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