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July 30, 2004

The Treasury has been issuing guidance on the new Health Savings Accounts in bits and pieces since the HSA provisions became law last December. Earlier this month the IRS issued comprehensive guidance that should clear up most remaining questions about these new IRA-like savings vehicles. Using a question and answer format, IRS Notice 2004-50 answers 88 questions about HSAs.


Health Savings Accounts are investment accounts that can be funded by taxpayers with "High-deductible" health insurance plans. Taxpayers with such plans can make tax-deductible contributions to the plans. Plan earnings and withdrawals are tax-free if used to pay health care expenses. Plan earnings not need for health care expenses can be withdrawn on a taxable basis under rules similar to the IRA rules.


The new HSA guidance makes clear that an when an employer offers employees a choice between a high-deductible plan and a "traditional" health plan, employees choosing the high-deductible plan qualify for HSAs. It confirms that employee assistance plans and prescription discount cards do not disqualify health plans from HSA coverage. It discusses "preventative care" that can be paid by the plan before the deductible is met without disqualifying the insured from HSA eligibility.


The plan confirms (Q&A 39) that HSA owners can carry over expenses from year to year for later tax-free reimbursement. For example, a 40-year old taxpayer starts an HSA in August 2004. Each year he incurs $2000 in out-of-pocket health costs, so over 25 years he has incurred $50,000 in unreimbursed medical expenses. If he hasn't withdrawn any funds from his HSA for 25 years, he can withdraw up to $50,000 tax-free. The catch: he has to be able to document those old expenses.


Some trust departments have been reluctant to become HSA trustees because they don't want to monitor whether HSA withdrawals are for qualified health care. They need not worry. Not only are trustees not required to verify whether the beneficiary is making a withdrawal for qualified medical expenses, they aren't allowed to. Q&A 79 of the notice provides:

   The HSA trust or custodial agreement may 
   not contain a provision that restricts HSA
   distributions to pay or reimburse only the 
   account beneficiary’s qualified medical 
   expenses. Thus, the account beneficiary is 
   entitled to distributions for any purpose and 
   distributions may be used to pay or 
   reimburse qualified medical expenses or for 
   other nonmedical expenditures. Only the 
   account beneficiary may determine how the 
   HSA distributions will be used.

Notice 2004-50 enables taxpayers to establish HSAs with confidence about the tax effects. Employers should ask their insurance carriers about adding a high-deductible plan with their next health insurance renewal. The premiums on such plans are lower, and some employees may appreciate the opportunity to establish an HSA. Tax-deductible contributions and tax-free withdrawals are hard to beat.


A "high-deductible" plan has to meet certain standards:

- 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.

The contribution limits are:

-Individuals (self-only coverage): 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.

The BenefitsBlog has more on Notice 2004-50.

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