Product Overview
HSAs were created by Medicare legislation signed into law by President Bush on December 8, 2003. This investment account is designed to enable individuals with a High Deductible Health Plan (HDHP) to save money for qualified medical expenses.
HSAs offer three key tax advantages:
- Contributions are tax-deductible.
- Earnings may accumulate tax-free.
- Withdrawals for qualified expenses are tax-free.
- Benefits
- Eligibility
- HDHP Requirements
- Portability
- Contributions
- Distributions
- Qualified Medical Expenses
- Tax Treatment
Benefits of an HSA to an Individual
- Contributions are tax deductible and any interest or investment returns accumulate tax-free.
- Unused funds in the account remain until they are used - there is no "use-it-or-lose-it" provision.
- Distributions are tax-free if they are used to pay for qualified medical expenses of the account holder, spouse, or dependents.
- Qualified expenses include a broad range of items that the individual may currently be paying for using post-tax dollars (for example, routine vision and dental visits or over-the-counter medicines). Moreover, there is no need for pre-authorization, unless stated in the plan.
- The account and assets belong to the employee and can be transferred from one employer to another.
Benefits of an HSA to an Employer
- Employer contributions are tax-deductible.
- Cut down on the costs of medical coverage (insurance premiums should reduce substantially when switching to a high-deductible health plan).
- Offer employees alternate ways to allocate their health benefit allotments.
- Educate employees on the true costs of healthcare coverage.
- Provide employees with incentives to get involved in healthcare decisions.
Eligibility for an HSA
An individual is eligible to have contributions made to an HSA for any month the individual is:
- Covered under a high deductible health plan (HDHP)
- Not covered by any other health plan that is not an HDHP
- Not enrolled for Medicare benefits
- Not claimed as a dependent on another person's tax return
Unlike requirements for other tax-advantaged savings plans, an individual does not have to meet any income standards or have earned income in order to participate.
High Deductible Health Plans Requirements
A high deductible health plan (HDHP) is a plan with the annual minimum deductible and maximum out-of-pocket expenses for single or family coverage. The plan won't provide benefits until the deductible for that year has been met.
Note: An insurance professional should verify that the HDHP in question is actually a qualified plan. Penalties exist for individuals who open HSA accounts without the appropriate insurance.
Portability
The account belongs to the individual, not the employer. Employees may take the assets when leaving or changing employers.
Contributions
Anyone, including an employer, can make contributions on behalf of an individual. All contributions are aggregated. If the employer contributes, the amount will be excluded from income and the employer gets the benefit of the deduction.
Contribution Limits - For an eligible individual covered by the same HDHP plan for the entire calendar year, the maximum annual contribution is the deductible amount (excluding any out-of-network deductible) not to exceed the annual limits for single or family coverage.
(The maximum monthly contribution is 1/12th of the maximum funding level for each month the member is covered by the HDHP.)
Catch-Up Contributions - Individuals who age 55 or older (until they enroll for Medicare) may make HSA catch-up contributions.
Timing - The HSA can be funded in one or more payments and must be done prior to the individual's federal tax filing date (generally April 15).
Employer Contributions - If an employer contributes to the HSA it must make comparable contributions for all participants. Contributions are considered comparable if they are either the same dollar amount or the same percentage of the HDHP deductible.
Distributions
Withdrawals from HSAs are tax-free if they are used to pay for qualified medical expenses of the account holder, his or her spouse, or dependents.
Timing - There is no time limit on when distributions must occur, and an individual is permitted to make withdrawals at any time.
Nonqualified Withdrawals - Nonqualified withdrawals prior to age 65 are taxable and a 10% penalty applies; nonqualified withdrawals post age 65 are taxable but no penalty applies.
Qualified Medical Expenses
Allowable reimbursements are defined by I.R.C. Section 213(d). Qualified medical expenses include:
- Diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function on the body
- Transportation for the essential medical care listed above
- Over-the-counter drugs
- Qualified long-term care insurance
- COBRA health-care continuation coverage
- Healthcare coverage while an individual is receiving unemployment compensation
Note: Expenses incurred before the HSA was established are not qualified, distributions from the HSA cannot be used to pay them.
HSA cannot be used for health insurance except:
- Long-term care insurance
- Premiums for COBRA continuation
- Premiums for health coverage while an individual is receiving unemployment
- For Medicare eligible employees:
- Medicare parts A & B
- Medicare HMO coverage
- Retiree contributions to employer sponsored coverage
- Medigap policies are not allowed
Tax Treatment
Employer Tax Deductibility - Employer contributions to the HSA:
- Are tax deductible to the employer in the year contributed
- Do not require income tax withholding from employees' wages
- Are not subject to Federal Insurance Contributions Act (FICA) or Federal Unemployment Tax Act (FUTA)
For purposes of discrimination testing, only the amounts contributed by the employer are considered.
Employee Tax Deductibility - Employee contributions can be made pre-tax through a Section 125 plan. If the employer does not sponsor a Section 125 plan, the employee can take an above the line tax deduction on their Form 1040 (even if they don't otherwise itemize). The earnings within the HSA are not taxed if used for qualified health care expenses.
Distributions - Distributions from HSAs may be exempt from federal income tax and penalties, depending on whether or not the distribution is used to pay for qualified medical expenses.
Qualified distributions - Distributions for qualified medical expenses of the account holder, his or her spouse, or dependents are exempt from federal income tax and penalties.
Nonqualified distributions - Distributions that are not used for qualified medical expenses are always includable in the individual's gross income. In addition, nonqualified distributions are subject to an additional 10 percent penalty, unless the distribution is made after the account holder's death, disability, or attainment of age 65.
The account holder is responsible for determining whether an HSA distribution is qualified or nonqualified. It's a good idea, therefore, to maintain records of medical expenses sufficient to show that the distributions were made exclusively to pay for qualified medical expenses, and are, therefore, excludable from gross income.
Required Tax Reporting - Employer contributions to an HSA must be reported on the employee's Form W-2. The HSA trustee or custodian is responsible for filing required information returns with the IRS (Form 5498-SA and Form 1099-SA).
The information contained on these pages is for general educational purposes only, individuals should consult their financial advisor or legal counsel to determine how these regulations affect their unique situation.
