Understanding Health Savings Accounts

Fitness employers, employees and self-employed professionals alike have all been grappling with the dilemma of expensive and continually rising medical insurance premiums, with no end in sight. Fortunately, the United States federal government has recognized this burden to both small businesses—fitness and otherwise—and to citizens. In order to provide needed assistance in this area, in 2003 Congress passed—and President Bush signed—the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Provisions of this law created, among other things, Health Savings Accounts (HSAs), which replaced Archer Medical Savings Accounts. (The Archer accounts never really gained any traction with taxpayers.)

HSAs, a new option for health insurance, became available January 1, 2004. Now, nearly 2 years later, some of the uncertainties about them are being clarified, and more people are using them. Learn whether you’re eligible for an HSA, how the accounts work and what their benefits are to employers, employees and the self-employed.

How do you know if you can get an HSA? According to the U.S. Department of the Treasury, you are eligible for a Health Savings Account if

• you are covered by a High-Deductible Health Insurance Plan (HDHP);
• you are not covered by other health insurance (does not apply to specific-injury insurance and accident; disability; and dental care, vision or long-term care);
• you are not eligible for Medicare; and
• you can’t be claimed as a dependent on someone else’s tax return.

Health Savings Accounts have two parts. The first part is an HDHP, which is a health insurance policy that covers large hospital bills, according to HSAInsider .com. The second part is an investment account from which you can withdraw money tax-free to pay for qualified medical expenses. If the investment account is large enough, it will accumulate with tax-deferred income until retirement. At that time you can withdraw from it for any purpose and pay normal income taxes, similar to an IRA or a 401(k) account.

Employers or individuals can obtain the required health insurance policies at a substantially reduced cost compared with traditional low-deductible medical insurance policies. Employers can pass much of the costs of these policies onto the employees. The good news is that covered eligible employees can pay their share of the insurance costs with pretax rather than after-tax dollars. By paying the additional costs with pretax rather than after-tax dollars, the net after-tax costs to the individual participants are substantially lower than they otherwise would be.

Eligible individuals who participate in HSAs can obtain a current tax deduction for amounts put into their HSA accounts. In addition, participants do not have to pay income taxes on either earnings or distributions from HSAs as long as they are used to pay for qualified medical expenses.

An HDHP is a plan that has an annual deductible of at least $1,000 ($2,000 for family coverage) and that limits out- of-pocket expenses to $5,000 per year ($10,000 for family coverage), exclusive of insurance premiums.

As of the writing of this article, 93 companies offer HDHP coverage, although not all carriers offer them in all states. Speak with your health insurance professional or insurance broker to obtain information and quotes for HDHPs. To learn more, go to www.hsainsider.com. This site provides a wealth of information about HSAs.

The money in your HSA account can be used to pay for qualified medical expenses; that is, medical and dental expenses that would otherwise qualify to be itemized deductions under the Internal Revenue Code. Normally these expenses include unreimbursed payments for doctors, hospitals, medications, eyeglasses and contact lenses, medical lab fees, chiropractors, nursing-home costs, physical therapy, psychiatric and psychological costs, x-rays, medical equipment and supplies, etc. An HDHP may, but is not required to, provide preventive-care benefits, according to Notice 2004-23 of the Internal Revenue Service. Preventive-care benefits include health evaluations, tests and diagnostic procedures in connection with routine examinations and annual physicals; prenatal and well-child care; immunizations; tobacco use cessation; obesity weight-loss programs; and certain screening services.

A “safe-harbor” (place of safety) list of screening services was created by Notice 2004-23. You can definitely deduct these costs from your HSA account, while other deductions in the same area are not as certain. For items that fall within the safe-harbor list, extensive research is not required to support the deductions. The safe- harbor services include conditions related to cancer, heart and vascular disease; infectious diseases; mental-health conditions; substance abuse; metabolic, endocrine and nutrition-related conditions; musculoskeletal disorders; OB/GYN conditions; pediatric conditions; and vision and hearing disorders. Obtain Publication 502, Medical and Dental Expenses from the Internal Revenue Service for further information on such qualified expenses.

Any money you take from your HSA that is not used for qualified medical expenses is taxable as ordinary income. In addition, there is a 10% penalty on this money. (If you are over age 65 and take this kind of distribution, the 10% penalty will not apply, but you will be assessed income taxes.)

How much can you contribute to an HSA? The contribution is the lesser of

1. the insurance deductible, which must be $1,000 or more per year for an individual or $2,000 or more per year for a family, or

2. $2,650 for an individual ($5,250 for a family) per year.

These amounts will be adjusted for inflation in the future. If you are 55 or older, you can make a supplemental contribution of $600 for 2005. This amount will increase by $100 per year until 2009, when the additional amount will be capped at $1,000.

If you participate in HSA plans when you are young and generally healthy, you can accumulate a substantial nest egg. In fact, in a worst-case scenario, any unspent money will have the same tax characteristics as a traditional IRA account. That, in and of itself, is a reason to participate in an HSA if one is available to you.

As is the case with many areas of the tax law, HSAs are complex and you must fulfill specific requirements in order to qualify for one. Accordingly, if you are interested in establishing an HSA for yourself or your employees, obtain the advice and counsel of knowledgeable professionals—your certified public accountat, tax lawyer and/or insurance professional—before establishing such a plan.

An HSA lets you take advantage of these powerful benefits:

1. You may claim a tax deduction for amounts that you contribute to an HSA.

2. You may claim the tax deduction even if you do not itemize your deductions for income tax purposes.

3. If your employer makes contributions to an HSA on your behalf, the amounts may be excluded from your gross income for tax purposes.

4. Any unspent amounts will remain in your account from one year to the next until you use them. Thus, you don’t have to worry that you will lose the money if you don’t use it.

5. Interest, dividends and other earnings in the account are tax free if you use them for qualified medical expenses.

6. The tax-free (or deferred) earnings, as well as unspent amounts, will have the benefit of compounding and thus will grow, providing even more of a benefit.

7. Distributions will be tax-free if you use them for qualified medical expenses.

8. The accounts are portable so you can take them with you if you change employers or if you leave the workforce.

The money in your HSA account can be used to pay for qualified medical expenses; that is, medical and dental expenses that would otherwise qualify to be itemized deductions under the Internal Revenue Code.

Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans from the Internal Revenue Service

www.hsainsider.com (The “Ask the Expert” function lets you ask a question that is then answered. Answers to previous “Ask the Experts” questions are archived on the website.)