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Health Savings Account (HSA)

A Health Savings Account (HSA) is a special account owned by an individual used to pay for current and future medical expenses.

  • HSAs are used in conjunction with a “High Deductible Health Plan” (HDHP).
  • Insurance that does not cover first dollar medical expenses (except for preventive care)
  • Can be an HMO, PPO or indemnity plan, as long as it meets the requirements
  • HSAs were created in Medicare legislation signed into law by President Bush on December 8, 2003
  • HSAs modeled after Archer MSAs

Any individual that:

  • Is covered by an HDHP
  • Is not covered by other health insurance
  • Is not enrolled in Medicare
  • Can’t be claimed as a dependent on someone else’s tax return
  • Children cannot establish their own HSAs
  • Spouses can establish their own HSAs, if eligible

No income limits on who may contribute to an HSA
No requirement of having earned income to contribute to an HSA

What other health coverage is allowed for you to still be eligible for an HSA?

  • Specific disease or illness insurance and accident, disability, dental care, vision care and long-term care insurance
  • Employee Assistance Programs, disease management program or wellness program

These programs must not provide significant benefits in the nature of medical care or treatment

  • Drug discount cards
  • Eligibility for VA Benefits

Unless you have actually received VA health benefits in the last 3 months

Examples of “1st dollar” medical benefits that make someone ineligible for an HSA:
Tricare Coverage
Flexible Spending Arrangements
Health Reimbursement Arrangements

There are permitted HSA/HRA/FSA combinations:
“Limited purpose” FSAs and HRAs that restrict reimbursements to certain permitted benefits such as vision, dental, or preventive care benefits
“Post-deductible” FSAs or HRAs that only provide reimbursement after the minimum annual deductible has been satisfied under the HDHP
“Retirement” HRAs that only provide reimbursement after an employee retires
“Suspended” HRAs where the employee has elected to forgo health reimbursements for the coverage period

Prescription Drugs
If HDHP provides prescription drug benefit, prescription drug expenses must be subject to the annual deductible or the individual may not contribute to an HSA.

Preventive Care
Preventive care generally does not include any service or benefit intended to treat an existing illness, injury or condition.
Certain drugs and medications can be considered preventive care.
Drugs taken by a person who has developed risk factors for a disease that has not yet manifested itself or to prevent reoccurrence of a disease
Example:  Cholesterol-lowering medication for those with high cholesterol

Safe harbor list of preventive care that HDHP can provide as first-dollar coverage before minimum deductible is satisfied:
Periodic health evaluations (e.g., annual physicals)
Screening services (e.g., mammograms)
Routine pre-natal and well-child care
Child and adult immunizations
Tobacco cessation programs
Obesity weight loss programs
Can apply co-pays to preventive care services

Contributions to HSA can be made by the employer or the individual, or both
If made by the employer, it is not taxable to the employee (excluded from income and wages)
If made by the individual, it is an “above-the-line” deduction
Can be made by others on behalf of individual and deducted by the individual
Individuals can make a one-time transfer from their IRA to an HSA, subject to the contribution limits applicable for the year of the transfer. 

Contributions must stop once an individual is enrolled in any type of Medicare.
Contributions to the HSA in excess of the contribution limits must be withdrawn by the individual or be subject to an excise tax.
A pro-rata portion of earnings must be withdrawn also Pay income tax on the withdrawn amount, but no 10% penalty.
If the HSA maximum contribution limit was not reached for the year, any other withdrawal for the year (that is not for qualified medical expenses) will not be considered “excess HSA contributions” and that withdrawal will be subject to both income tax and the 10% penalty.

Can be made by a salary reduction arrangement through a cafeteria plan (125 plan)
Elections to make contributions through a cafeteria plan can change on a month-by-month basis (unlike salary reduction contributions to an FSA)
Remember that contributions to the HSA through a cafeteria plan are “pre-tax” and not subject to individual or employment taxes.
Employer can automatically make cafeteria plan contributions on individuals’ behalf unless the individual affirmatively elects not to have such contributions made (“negative elections”)
Are always excluded from employees’ income (pre-tax)
Must be “comparable” for all employees participating in the HSA
If not comparable, there will be an excise tax equal to 35% of the amount the employer contributed to employees’ HSAs
The self-employed, partners and S-Corporation shareholders are generally not considered employees and cannot receive an employer contribution
They can make deductible contributions to the HSA on their own

Comparable contributions are contributions to all HSAs of an employer:

  • Which are the same amount or which are the same percentage of the annual deductible 
  • May count only employees who are “eligible individuals” covered by the employer under the HDHP and who have the “same category of coverage” (i.e., self-only or family).
  • No other classifications of employees are permitted
  • Part-time employees can be tested separately.
  • "Part-time” means customarily employed fewer than 30 hours per week
  • Employers may contribute more on behalf of nonhighly compensated employees.

Comparability rules do not apply to collectively bargained employees.

  • Employer matching contributions to the HSA through a cafeteria plan are not subject to the comparability rules 
  • Cafeteria plan nondiscrimination rules apply contributions cannot be greater for higher paid employees than they are for lower paid employees contributions that favor lower paid employees are OK 
  • Employer contributions to an HSA based on an employee’s participation in health assessments, disease management program or wellness program do not have to satisfy the comparability rules if the employees are allowed to contribute to the HSA through a cafeteria plan to the HSA

Cafeteria plan nondiscrimination rules also apply
Violations of the Comparability Rules

Extra contributions to an HSA on account of employees who meet a specified age or qualify for the catch-up contributions
Contributions based on length of service

Distribution is tax-free if taken for “qualified medical expenses”.

Now includes over-the-counter drugs

Qualified medical expense must be incurred on or after the HSA was established.
If HDHP coverage effective on first day of month, HSA can be established as early as first day of same month
If HDHP coverage effective any day other than first day of month, HSA cannot be established until first day of following month

Tax-free distributions can be taken for qualified medical expenses of:
person covered by the high deductible
spouse of the individual (even if not covered by the HDHP)
any dependent of the individual (even if not covered by the HDHP)

If distribution is not used for qualified medical expenses

Amount of distribution is included in income and
10% additional tax except when taken after:
Individual dies or becomes disabled
Individual is age 65
“Qualified medical expenses” do not include other health insurance (including premiums for dental or vision care)

COBRA continuation coverage
Any health plan coverage while receiving unemployment compensation

For individuals enrolled in Medicare:
Medicare premiums and out-of-pocket expenses (Part A, Part B, Medicare HMOs, prescription drug coverage)
Employee share of premiums for employer-based coverage
Cannot pay Medigap premiums
Qualified long-term care insurance premiums

Should the HSA account holder keep receipts? YES!
May need to prove to IRS that distributions from HSA were for medical expenses and not otherwise reimbursed
May be required by insurance company to prove that HDHP deductible was met
Not all medical expenses paid out of the HSA have to be charged against the deductible (e.g. dental care, vision care)
HSA Distributions can be used to reimburse prior years’ expenses as long as they were incurred on or after the date the HSA was established.
No time limit on when distribution must occur Individual must keep records sufficient to prove that: the expenses were incurred, they were not paid for or reimbursed by another source or taken as an itemized deduction

Mistaken HSA distributions can be returned to the HSA.
Clear and convincing evidence must be shown that the distribution was a mistake of fact
Must be repaid by April 15 of the year following the year in which the individual knew or should have known the distribution was a mistake

Treatment of HSAs upon Death
If the spouse is the beneficiary, the spouse inheriting the HSA is treated as the owner
To the extent the spouse is not the beneficiary:
The account will no longer be treated as an HSA upon the death of the individual
The account will become taxable to the decedent in the decedent’s final tax return if the estate is the beneficiary, otherwise, it will be taxable to the recipient.
Taxable amount will be reduced by any qualified medical expenses incurred by the deceased individual before death and paid by the recipient of the HSA
The taxable amount will also be reduced by the amount of estate tax paid due to inclusion of the HSA into the deceased individual’s estate

Accounts are owned by the individual (not an employer). The individual decides:
Whether he or she should contribute
How much to use for medical expenses
Which medical expenses to pay from the account
Whether to pay for medical expenses from the account or save the account for future use
Which company will hold the account
What type of investments to grow account
Employer cannot restrict
What distributions from an HSA are used for Rollovers

HSA Custodian or Trustee can put reasonable limits on accessing the money in the account
Frequency of distributions
Size of the distributions

Who can be an HSA Trustee or Custodian?
Banks, credit unions
Insurance companies
Entities already approved by the IRS to be an IRA or Archer MSA trustee or custodian
Other entities can apply to the IRS to be approved as a non-bank trustee or custodian
IRS has provided model HSA Trustee and Custodian Forms.

Trustee or custodian fees
Can be paid from the assets in the HSA account without being subject to tax or penalty.
Can be directly paid by the beneficiary without being counted toward the HSA contribution limits.

HSA trustee must report all distributions annually to the individual (Form 1099 SA).
Trustee not required to determine whether distributions are used for medical purposes; the individual does that.
Individual will report on annual tax return amount of distribution used for qualified medical expenses
Account holders must file Form 8889 as part of their annual tax return.

No “use it or lose it rules” like Flexible Spending Arrangements (FSAs).
All amounts in the HSA are fully vested
Unspent balances in accounts remain in the account until spent
Encourages account holders to spend their funds more wisely on their medical care
Encourages account holders to shop around for the best value for their health care dollars