Health Savings Account Q&A

Author: Mary Deibel

Published: February 17, 2004

Tax-free Health Savings Accounts promoted by President Bush are starting to be marketed to 40 million Americans said to qualify for this new kind of health coverage.

The less-publicized part of the new law providing Medicare drug coverage to seniors, Health Savings Accounts are for people under 65 who take out qualified high-deductible health insurance policies and don't have other coverage.

These accounts can be used to pay out-of-pocket medical costs until high-deductible health insurance coverage kicks in.

The tax-free accounts initially were supposed to cost the federal government $6.4 billion over the next decade. But Treasury Secretary John Snow upped the estimate to $16 billion; the new Bush budget would add $70 billion more in HSA tax sweeteners.

If you're shopping for health insurance, here's what you should know:

Q: Who can open an HSA?

A: You must be under 65, not be claimed as someone's dependent and cannot have other general health insurance. You can have dental, vision, disability or long-term-care coverage, but not an overall policy you bought or were provided as an employee benefit. Also, you should make enough money to owe income tax or you don't get the write-off.

Q: Do all high-deductible health policies qualify for opening an HSA?

A: Policies must meet requirements of the Internal Revenue Service and state insurance regulators who approve insurance policies. To qualify, a policy's deductible must be at least $1,000 for individuals and $2,000 for families, and annual out-of-pocket expenses cannot exceed $5,000 for an individual or $10,000 for a family including co-payments, but not the insurance policy's premiums.

Contributions to the HSA are tax-deductible, and any employer contributions are not taxable to you or your employer.

The maximum HSA contribution that can be made by you, your employer or both cannot exceed the insurance policy deductible that is $2,600 maximum for individuals or $5,150 for families, whichever is lower. In 2004, participants 55 to 64 years old can kick in another $500 to their HSA, which will gradually rise to $1,000 a year by 2009.

You must spend up to the deductible set by your insurance policy before its coverage kicks in except for certain "wellness" services the policy specifies.

Q: Do after- or before-tax dollars fund an HSA?

A: Contributions are tax-free when made and grow tax-free the way contributions do in a traditional tax-deductible Individual Retirement Account.

Unlike a traditional IRA, HSA withdrawals are tax-free, too, if the money pays for qualified medical expenses: doctor visits, prescription drugs, hospital costs, vision and dental exams and the like. The law also allows tax-free withdrawals for long-term-care premiums or COBRA insurance premiums, which let you buy temporary coverage from your former employer if you lose your job.

Withdraw the money for a non-medical expense and you will owe income tax plus a 10 percent penalty if you're younger than 65.

Q: How does an HSA differ from my Flexible Spending Account at work?

A: Flexible Spending Accounts use before-tax dollars to cover deductibles, co-payments and other out-of-pocket medical costs, but the money is use-it-or-lose-it every year. HSAs let you roll over the balance year to year, and an HSA goes with you if you lose or change your job.

Q: Can I use HSA tax-free money to buy that high-deductible policy?

A: No, the account cannot be tapped to pay policy premiums.

However, the president's budget proposes a tax sweetener: If Congress approves - a big "if" because of that $70 billion price tag - taxpayers with HSAs would get an "above-the-line" deduction that lets them subtract premium payments from adjusted gross income, whether they itemize or not.

Otherwise, says attorney-accountant Mark Luscombe of tax publisher CCH Inc., the tax codes limit the deductibility of health insurance premiums. Individuals who itemize can deduct health insurance premiums to the extent that premiums and unreimbursed medical expenses exceed 7 percent of their adjusted gross incomes, he said. Self-employed taxpayers or owner-employees of certain small businesses - so-called S corporations - also can write off 100 percent of health-care premiums for themselves, their spouses and dependents, Luscombe said.

Q: Can I buy an HSA through my employer?

A: Yes, but maybe not right away. Employers who offered the old tax-favored Archer Medical Savings Accounts probably automatically changed to HSAs since the new law took effect Jan. 1, 2004. Otherwise, the IRS is still writing regulations for employer benefit plans.

Seventeen percent of employers with 5,000 employees or more had high-deductible options last year before HSAs began, the Kaiser Family Foundation reports. Urban Institute economist Len Burman says that 20 percent of large employers may offer HSAs tied to high-deductible policies by next fall.

Q: Can I open an HSA myself?

A: Some carriers that offered Archer Medical Savings Accounts have begun marketing HSAs. Golden Rule, Destiny Health and Assurant Health (formerly Fortis Health) are among those to start marketing HSAs to individuals or small employers.

Aetna expects to roll out a plan this quarter to employers, but others including Humana and the Blues are waiting on final IRS regulations.

Q: What features do plans have?

A: Offerings are still being developed, but don't just look at what the policy will cover this year. Consider lifetime maximums. For instance, Assurant vice president Scott Krienke says his firm has high-deductible policies that cover $2 million in lifetime medical expenses all the way up to $8 million.

Also look at the investment choices for HSA money just like you would an IRA or 401(k). Banks, mutual funds and brokerage houses are joining insurers - and in some cases partnering with them - to develop a range of HSA investment plans.

Other options include debit cards that subtract money directly from your HSA and keep a running tally of out-of-pocket costs to trigger insurance coverage when the deductible is met.

Until choices firm up, and until you see if you're a good candidate for an HSA, the Financial Planning Association suggests keeping some money invested in low-risk liquid assets to meet medical expenses.

Q: What else should I shop for?

A: As with any health policy, pre-existing conditions aren't covered by these new health plans, Krienke says.

However, early retirees who aren't eligible for Medicare because they're under 65 can continue to contribute to their HSA to cover conditions their policy covered before, whether it was provided by their employer or purchased individually.

Q: What happens once I'm 65?

A: You can't open an HSA or make new contributions at 65.

But if you didn't use up the money year to year, you should have a sizeable account by then and "it becomes your way to finance, tax-free, any retirement medical needs," says Don Weigandt, managing director of J.P. Morgan Private Bank.

At 65, tax-free HSA funds can be tapped for Medicare premiums, long-term care and other health expenses not covered by Medicare or other insurance. Withdraw money for other reasons and there's no 10 percent penalty, although you do owe income tax.

Q: What if I die?

A: The HSA goes to your named beneficiary. If you designate your spouse, the money is tax-free. If your beneficiary is someone else, he or she generally will owe income tax but no penalty, Mercer Human Resources consultants report.