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THE NEW HEALTH SAVINGS ACCOUNTS: HOW THEY WORK

December 08, 2003

The Medicare legislation to be signed into law today includes a controversial approach to health insurance coverage: the "Health Savings Account," or "HSA."

The HSA program encourages individuals to adopt high-deductible policies by allowing deductible contributions to a personal self-insurance reserve - the HSA. Earnings in the HSA accumulate tax free; they can be withdrawn tax-free to pay medical expenses. Penalty-free taxable withdrawals of amounts not used for medical expenses may be made after age 65.

Supporters say several good things will come from HSAs:

-Consumers will spend health dollars more carefully if there is a larger deductible before insurance kicks in;

-Administrative costs will be reduced because routine expenses won't be paid by the insurance company.

-Savings will be encouraged because taxpayers will get to keep HSA amounts not spent.

Backers say health insurance under an HSA will work something like car insurance: State Farm doesn't process a claim for an oil change, and Geico doesn't cover your tune-up; why should Wellmark cover your flu shot?

We will leave others to sort out the policy implications of HSAs. The important issue is, what's in it for us on April 15?

WHO QUALIFIES?

Taxpayers need to have a "high deductible" health insurance policy to qualify. This means:

- a deductible of at least $1,000 for single coverage or $2,000 for family/joint coverage.

-The out-of-pocket maximum per year cannot exceed $5,000 for single coverage and $10,000 for family/joint coverage.

-The taxpayer cannot be covered by a non-qualifying policy for items covered by the high-deductible policy.

HOW MUCH CAN I CONTRIBUTE AND DEDUCT?

-Individuals (self-only coverage): the maximum contribution and deduction is the lesser of $2,600 or the annual policy deductible

-Families: lesser of $5,150 or the annual deductible

-Taxpayers over 55 can contribute an additional $500.

-There is no phase-out for high-income taxpayers. This is one of the controversial aspects of the HSA as enacted.

WHAT ABOUT EMPLOYER CONTRIBUTIONS?

Employers can contribute to HSAs to the extent contributions by an employee would be deductible. To the extent the employer funds an HSA, the employee may not make a contribution. Employer contributions are tax-free to the employees.

HOW CAN I GET AT MY HSA SAVINGS WITHOUT PENALTY?

HSA savings can be withdrawn tax-free to cover medical expenses. They can be withdrawn as taxable distributions without penalty at age 65, or if the taxpayer is disabled. Other withdrawals are subject to a 10% early withdrawal penalty.

As a practical matter, many taxpayers will pay their out-of-pocket medical expenses with after-tax non-HSA dollars, allowing their HSAs to accumulate as a tax-deferred savings vehicle.

WHAT ABOUT MY MEDICAL SAVINGS ACCOUNT (MSA)?

Taxpayers with MSAs will find that the HSA is very similar in concept to the MSA. MSAs are limited to employees of small companies and to self-employed taxpayers. While the MSA rules are unaffected by the HSA legislation, it is likely that many MSA owners will shift to the less restrictive HSA format. MSA owners will be able to roll their existing accounts into HSAs tax free.

WHEN CAN I START AN HSA? HOW?

The HSA legislation takes effect for 2004. Interested taxpayers should consult their employers about whether their coverage includes a high-deductible option. Self-employed taxpayers and employers can already find high-deductible plans from, among others, Golden Rule Insurance and Wellmark. Because it will be much easier to qualify for HSAs than the old MSAs, insurers are likely to respond with more high-deductible policy choices.

Insurers have provided trustee services for MSA accounts. If HSAs catch on, more banks and mutual fund companies are likely to trustee MSAs.

UPDATE: a Treasury fact sheet on HSAs is here.

UPDATE II: Aetna had a full-page ad in the December 9 Wall Street Journal for their new HSA product. It will be interesting to see whether this catches on.

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