Friday, February 22, 2008

some thoughts on health savings accounts

an hsa is a tax - advantaged medical savings account available to taxpayers in the us who are enrolled in a high deductible health plan (hdhp). the funds contributed to the account are not subject to federal income tax at the time of deposit. funds may be used to pay for qualified medical expenses at any time without federal tax liability. withdrawals for non-medical expenses are treated very similarly to those in an ira account in that they may provide tax advantages if taken after retirement age, and they incur penalties if taken earlier. these accounts are a component of consumer-driven health care.

proponents of HSAs believe that they are an important reform that will help reduce the growth of health care costs and increase the efficiency of the health care system. according to proponents, HSAs encourage saving for future health care expenses, allow the patient to receive needed care without a gate keeper to determine what benefits are allowed and make consumers more responsible for their own health care choices through the required hdhp. opponents of HSAs say they worsen, rather than improve, the us health system's problems because people who are healthy will leave insurance plans while people who have health problems will avoid HSAs. there is also considerable debate about consumer satisfaction with these plans.

deposits to an HSA may be made by any policyholder of a minimum deductible health plan or by their employer, or any other person. if an employer makes deposits to such a plan on behalf of its employees, non-discrimination rules still apply — that is, all employees must be treated equally. however, if contributions are made through a section 125 plan, non-discrimination rules do not apply. employers may treat full-time and part-time employees differently, and employers may treat individual and family participants differently. (the treatment of employees who are not enrolled in a minimum deductible plan is not considered for non-discrimination purposes.) also, for 2007, employers may contribute more for non-highly compensated employees than highly compensated employees.

contributions from an employer or employee may be made on a pre-tax basis through an employer. if this option is not available through the employer, contributions may be made on a post-tax basis and then used to decrease gross taxable income on the following year's form 1040. the main advantage of making pre-tax contributions is the FICA and FUTA deduction, which amounts to a savings of 7.65% to the employer and employee. the self-employed must pay self-employment tax on their contributions. regardless of the method or tax savings associated with the deposit, the deposits may only be made for persons covered under a minimum deductible plan, with no other coverage beyond certain qualified additional coverage.

initially, the annual maximum deposit to an HSA was the lesser of the actual deductible or specified irs limits. congress later abolished the limit based on the deductible and set statutory limits for maximum contributions. for example, the 2008 statutory limits are $2,900 individual and $5,800 family. all contributions to an HSA, regardless of source, count toward the annual maximum. a catch-up provision also applies for plan participants who are age 55 or over, allowing the IRS limit to be increased.

all deposits to an HSA become the property of the policyholder, regardless of the source of the deposit. funds deposited but not withdrawn each year will carry over into the next year. if the policyholder ends their insurance coverage, he or she loses eligibility to deposit further funds, but funds already in the HSA remain available for use.

the tax relief and health care act of 2006, signed into law on 12/20/06, added a provision allowing a one-time rollover of IRA assets to be used to fund up to one year's maximum HSA contribution.

state tax treatment of HSAs varies. depending upon the state, HSA contributions and earnings may or may not be subject to state taxes. funds in an HSA can be invested in a manner similar to investments in an ira. investment earnings are sheltered from taxation until the money is withdrawn (and can be sheltered even then, as discussed in the section below).

while HSAs can be "rolled over" from fund to fund, an HSA cannot be rolled into an IRA or a 401k, and funds from these types of investment vehicles cannot be rolled into an HSA, except for the one time IRA rollover allowed above. unlike some employer contributions to a 401(k) plan, all HSA contributions belong to the participant immediately, regardless of the deposit source. a person contributing to an HSA is under no obligation to contribute to his or her employer-sponsored HSA, although employers may require that payroll contributions be made only to the sponsored HSA plan.

HSA participants do not have to obtain advance approval from their HSA trustee or their medical insurer to withdraw funds, and the funds are not subject to income taxation if made for qualified medical expenses. these include deductibles and coinsurance as well as many other expenses not covered under medical plans, such as dental, vision and chiropractic care; durable medical equipment such as eyeglasses and hearing aids; and transportation expenses related to medical care. non-prescription, over the counter medications are also eligible.

there are several ways that funds in an HSA can be withdrawn. some HSAs include a debit card, some supply checks for account holder use, and some allow for a reimbursement process similar to medical insurance. most HSAs have more than one possible method for withdrawal. the exact method of withdrawal varies from HSA to HSA and can be considered a marketing design issue. checks and debits do not have to be made payable to the provider. funds can be withdrawn for any reason, but withdrawals that are not for documented qualified medical expenses are subject to income taxes and a 10% penalty. the 10% tax penalty is waived for persons who have reached the age of 65 or have become disabled at the time of the withdrawal. then, only income tax is paid on the withdrawal, and in effect the account has grown tax deferred (similar to an IRA). medical expenses continue to be tax free.

account holders are required to retain documentation for their qualified medical expenses. failure to retain and provide documentation could cause the IRS to rule withdrawals were not for qualified medical expenses and subject the taxpayer to additional penalties.

when a person dies, the funds in their HSA are transferred to the beneficiary named for the account. if the beneficiary is a surviving spouse, the transfer is tax-free. HSAs are similar to medical savings account plans that were authorized by the federal government before HSA plans.

HSAs differ in several ways from MSAs. perhaps the most significant difference is that employers of all sizes can offer an HSA account and insurance plan to employees, while MSAs were limited to the self-employed and employers of 50 or fewer people.

HSA plans can clearly benefit two groups of people, those who are healthy and those who are very unhealthy or have large monthly expenses for medications. this is due to the fact that everything one spends on medications and office visits is credited towards the deductible. once the deductible is met, HSA plans will pay for medications with the same copay as all other medical expenses. this could limit the maximum out of pocket costs in some cases.

the premium for an HDHP generally is less than the premium for traditional health insurance. a higher deductible lowers the premium because the insurance company no longer pays for routine health care expenses, and insurance underwriters believe that, if americans see a relationship between medical cost and their bank accounts, they will consume less medical care, shop for bargains, and be more vigilant against excess and fraud in the health care industry. introducing consumer-driven supply and demand and controlling inflation in health care and health insurance were among the government's goals in establishing these plans.

with HSAs, in catastrophic situations the maximum out-of-pocket expense liability can be less than that of a traditional health plan because a qualified hdhp can cover 100% after the deductible, involving no coinsurance.

HSAs also give the flexibility not available in some traditional health plans to pay on a pretax basis for qualified medical expense not covered in standard or HSA insurance plans. this may include dental, orthodontics, vision, and non-prescription medications such as aspirin.

HSA accounts also have an advantage over flexible spending accounts since deposits are not necessarily tied to expenses in a particular plan or calendar year. they are automatically rolled over for future medical expenses, or may be used to reimburse qualified expenses from prior years as long as the expense was qualified under an HSA plan at the time incurred.

over a period of time, if medical expenses are low and contributions are made regularly to the HSA, the account can accumulate significant assets that can be used for health care tax free or used for retirement on a tax-deferred basis.

a recent industry survey found that in July of 2007 over 80% of HSA plans provided first-dollar coverage for preventive care. this was true of virtually all HSA plans offered by large employers and over 95% of the plans offered by small employers. it was also true of over half (59%) of the plans purchased by individuals. all of the plans offering first-dollar preventive care benefits included annual physicals, immunizations, well-baby and well-child care, mammograms and Pap tests; 90% included prostate cancer screenings and 80% included colon cancer screenings.

many consumer organizations and many medical organizations have rejected HSAs because, in their opinion, they benefit only healthy, younger people and make the health care system more expensive for everyone else. according to stanford economist victor fuchs, "The main effect of putting more of it on the consumer is to reduce the social redistributive element of insurance."

the fundamental problem of HSA compatible health plans is that insurance doesn't cover anything until the consumer pays a large deductible. some HSAs pay for basic preventive care, such as annual physicals and mammograms, but others do not. for example, a patient with a suspicious mammogram may have to pay $1,000 out of pocket for a biopsy to find out whether the cause is cancer. because there is no mandatory funding minimum, there may be a temptation by some users to underfund the account and later be caught short of funds. expenses may also be incurred before planned funding has taken place through scheduled payroll deductions.

another problem cited by opponents, particularly for low-income people who are more likely to be uninsured, is that the tax benefits offered by HSAs are too modest—when compared to the actual cost of insurance—to persuade significant numbers to buy this coverage.

in my opinion, the benefits of HSAs outweigh the negatives, and HSA proponents believe that they are an important reform that will help reduce the growth of health care costs and increase the efficiency of the health care system. according to proponents, HSAs encourage saving for future health care expenses, stimulate the adoption of High Deductible Health Plans, and move more health care expenses away from third-party payment. these plans require that the consumer take greater financial control over their health care than they would under a traditional health plan. day - to - day expenses come out of the health savings account, while catastrophic expenses are covered by insurance.

for example, an individual might have to choose between a $200 brand-name medication and a $20 generic medication. under traditional health insurance, the generic drug might have a $5 copay, while the brand-name drug might have a $15 copay. in this case, the individual might choose the brand-name drug, costing the health insurer $185. with many people making the same choice, the insurer would need to recoup by charging everyone higher premiums. an individual with a high-deductible health plan would likely make the economically efficient choice by choosing the generic drug. this would in turn translate into lower premiums for participants. by giving the consumer a choice and proper incentives, money is saved. if a truly catastrophic event happens, like a heart attack, health insurance is there to cover expenses over the deductible.

critics of HSAs question the validity of this argument and express doubt that individuals have the training and information necessary to make intelligent, cost-effective decisions. there is obviously significant debate in the policy community over these issues.

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