Health saving accounts have been slow to catch on. Despite glowing praise from administration officials, and even the president on several occasions, HSAs have been under-subscribed.
Nevertheless, their time will come, since HSAs have clearly been designed to provide definite advantages to a broad range of employers, employees and self-employed individuals.
HSAs have been available since Jan. 1, 2004. They provide upfront deductions, tax-free deferral of earnings and tax-free distributions. In fact, HSAs represent the first opportunity for most individuals to get an upfront deduction for contributions to a tax-deferred vehicle and then escape income tax on the distribution of those contributions and earnings. The policy reason behind this beneficence is to encourage patients to be price-conscious consumers of medical services.
There are several reasons for HSAs’ slow start.
The enabling legislation was signed only last December. Banks, insurance companies and other potential trustees have had scant time to ramp up their paperwork to offer them to the public. Most individuals who have been approaching their bank or broker to set one up have not gotten very far. Only a few insurance companies that had been handling medical savings accounts were prepared.
In addition, most employers are of a mindset to deal with health care benefits only once each year, during the traditional “open enrollment period” in the fall. To many, canceling or converting existing health plans to accommodate HSAs for the balance of 2004 seems not worth the bother, both in terms of working through the rules and presenting them to employees.
Finally, the rules themselves are not only complicated, but also vague on a number of counts. Questions are arising as to how the requirements for HSAs and their related high-deductible health plans relate to real-life health benefits actually being offered in the marketplace.
Now or later?
The IRS took a stab at clarifying the rules earlier this year, and has promised more guidance by June. Nevertheless, many practitioners are assuming that, with almost half the year gone, the time for setting up HSAs for 2004 has passed.
Preparations reportedly are being made by many businesses, however, to offer HSAs in the fall during open enrollment for 2005. This requires not only crunching cost-benefit analyses for the employers based on projected premiums or co-pay amounts; it also involves determining how best to present HSAs to employees as something that will benefit them, as well as their employers.
Self-employed individuals and those individuals otherwise without a health plan are also not freed from the decision-making process. In their case, however, it may be worthwhile to make a decision to open an HSA as soon as possible to maximize benefits.
Under normal circumstances, the maximum amount allowed to be contributed to an HSA is determined pro rata by month. However, to help jump-start HSAs, Notice 2004-24 provides that, as long as the HSA is established by April 15, 2005, it may be used to pay for qualified medical expenses incurred in calendar year 2004.
For 2004 only, maximum contributions will be determined based on the months in which the high-deductible plan is in place, not when both the HDHP and the HSA are in existence. On an annual basis, contributions are allowed up to the lesser of 100 percent of the annual deductible or $2,600 ($5,150 for family coverage), plus an extra $500 catch-up contribution for individuals age 55 or older.
For 2004 and 2005 only, the Internal Revenue Service also removed another roadblock to setting up an HSA. Some employers had set up HSAs under the assumption that prescription drug benefits, like vision and dental care, routine physicals and the like, were exempt from the high-deductible limit. Others have been holding back on HSAs under the opposite assumption. While the IRS clarified that prescription drugs are not generally exempt for the overall high deductible, it announced in Notice 2004-23 a “transition rule” that makes them exempt for 2004 and 2005.
In deciding whether an HSA is worthwhile, certain issues have been surfacing. This article offers several strategies arising from those issues.
Spouse as family
For 2004, a qualifying HDHP is one with an annual deductible of at least $1,000 for individual coverage or $2,000 for family coverage. “Family,” for this purpose, includes spouses, even in situations without children. This definition unfortunately leads to a marriage penalty that will impact whether some couples should opt for an HSA.
Many policies today require a per-person deductible but set the family deductible as the cap after which no deductible is imposed for other family members. Under the HSA rules, however, the HSA owner and his spouse in combination must reach the $2,000 level before any medical expense is reimbursed.
For example, a married owner with $1,400 in medical expenses cannot be reimbursed by an HDHP at all, while a single owner would be entitled to $400 as qualified for reimbursement.
Another downside of being one “family” involves the minimum amount considered as the deductible in qualifying the plan as an HDHP. If both spouses are covered by plans, the one with the lowest family deductible determines whether either is qualified for an HSA.
HSA as graduation gift
As May graduations roll around, the families of many graduating college students face the same insurance problem. The graduate suddenly is not covered by the family’s employer-provided medical insurance policy. HSAs will fit well into many of these situations.
A high-deductible plan is often the only economically feasible way to cover the graduate either while in graduate school or before finding a job with medical benefits. Now, an HSA can be paired with that high-deductible plan.
Even though the graduate owns the HSA, the rules allow anyone to make a direct contribution to it, as long as the maximum for the year is not exceeded. This allows the parent to make the contribution and the graduate to take a deduction against any current part-time wage or investment income (assuming the graduate is no longer a dependent under Code Sec. 151).
It also gives the graduate a substantial nest egg in the likely event that no medical expenses are incurred. That HSA nest egg, in which annual contributions are rolled over and grow tax free, can be used later in life to pay for medical expenses tax free, whether or not the child is covered at that time by an HDHP.
HSA in divorce
The rule that allows anyone to contribute to anyone else’s HSA within the HSA owner’s overall contribution limit also may be used to advantage in a divorce situation.
Medical coverage usually figures into determining alimony obligations. Now, one former spouse can cover the amount of the ex-spouse’s HSA contribution and receive an alimony deduction, while the benefiting spouse covers the corresponding alimony income with an HSA deduction of an equal amount.
Assuming that all other requirements are satisfied, a payment of cash by the payor spouse to a third party under the terms of the divorce or separation instrument will qualify as a payment of cash that is received “on behalf of a spouse.”
Long-term care insurance coverage
Certain members of Congress have tried for several years to qualify long-term care premiums as an above-the-line deduction. While unsuccessful so far, the likelihood of such a deduction remains high, due to the growing inability of the government to cover nursing home and similar costs.
However, in the meantime, HSAs provide some help. Medical insurance premiums are not reimbursable by an HSA. However, the cost of long-term care insurance coverage is reimbursable and, therefore, allows deductible contributions to be used for that purpose.
As had been the case with new Roth IRAs after the 1997 Tax Act, the rules for HSAs are taking a while to work out. While this confusion justifiably has some taxpayers sitting on the sidelines for the moment, HSAs, like the Roth IRA, appear to be here to stay.
Predictably, those taxpayers most in need of medical services on a continuing basis for chronic illnesses will not fare as well under the HDHP/HSA combination as they have under tradition health plans. Nevertheless, marketplace pressures for viable medical insurance alternatives continue to increase as premiums continue to outpace inflation.
HDHP/HSAs can lower, or at least hold down, medical insurance costs for many employers while keeping most employees reasonably satisfied with the result. The lure to some workers of “hitting the jackpot” by being able to roll over HSA contributions in a significant nest egg because of good health will help their acceptance.
The current administration’s determination to offer health savings accounts as a successful initiative no doubt will help guarantee fairly liberal rules on the remaining issues. That determination also will result in continued coverage of HSAs in the general media, making questions on HSAs from clients increasingly inevitable as we head into summer and fall.
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