Health Savings Accounts (HSAs) - A New Wave in Healthcare

HSA Health Savings Accounts - San Jose, California

What is a Health Savings Account?

The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 added section 223 to the Internal Revenue Code to permit eligible individuals to establish health savings accounts (HSAs) for taxable years beginning after December 31, 2003. An HSA allows individuals to pay for qualified health expenses and save for future qualified medical and retiree health expenses on a tax-free basis. An HSA is similar to an Individual Retirement Account ("IRA"). Like an IRA, an HSA is established for the benefit of an individual, is owned by that individual, and is "portable." Thus, if the individual is an employee who changes employers or leaves employment, the HSA stays with the individual. However, an IRA cannot be used as an HSA nor can you combine an IRA and an HSA in a single account.

Who is Eligible for an HSA

To be eligible for an HSA, you must be covered by a high deductible health plan and you must not be covered by other health insurance. (This restriction does not apply to insurance for specified illness or disease or accident, disability, dental care, vision care, long-term care or hospitalization insurance) In addition, you cannot be enrolled in Medicare nor can you be claimed as a dependent on someone else's tax return. You are also ineligible for an HSA if, while covered under a high deductible health plan, you are also covered (whether as an individual, spouse, or dependent) under a health plan that is not a high deductible health plan.

May an Individual Establish More Than One HSA?

An eligible individual may establish and contribute to more than one HSA. However, the rules governing HSAs, such as those setting maximum annual contribution limits, apply no matter how many HSAs are established by an eligible individual. Thus, for example, the account balances of all HSAs established by an individual are aggregated for purposes of applying the maximum annual contribution limit described below.

What is a "High Deductible Health Plan"?

A high deductible health plan is a health insurance plan that has a high annual deductible (determined yearly by the Treasury Department). See IRS Publication 969 at www.irs.gov for details.

Out-of-pocket expenses include deductibles, co-payments, and other amounts the participant must pay for covered benefits, but do not include premiums. High deductible health plans can have first dollar coverage (no deductible) for preventive care and higher out-of-pocket expenses (copays & coinsurance) for non-network services. (The dollar amounts described above are subject to annual cost of living adjustments.)

Who Can Offer a High-Deductible Health Plan?

A high-deductible health plan may be offered by a variety of entities, including insurance companies and health maintenance organizations (HMOs).

Are HSAs Allowed Under a Cafeteria Plan?

If a high deductible plan is offered as part of a cafeteria plan, it can be used to establish your eligibility for an HSA. (A cafeteria plan or flexible benefit plan is an employee benefit plan that permits employees to choose from a variety of benefits, including health and accident insurance cash, tax advantages and retirement plan contributions.)

May HSA Contributions Made Under a Cafeteria Plan Be Changed?

If you elect to make HSA contributions under a cafeteria plan, you may start or stop the election or increase or decrease the amount of your HSA contribution at any time, as long as the change is effective prospectively.

May an Individual Who Uses a Discount Card for Health Care Services or Products Contribute to an HSA?

A discount card-holder may be eligible to establish an HSA if the individual is covered by a high-deductible health plan and is required to pay health care costs, taking into account the discount, until the HDHP deductible is satisfied.

May an Individual Covered by an Employee Assistance Program (EAP), Disease Management Program, or Wellness Program Establish an HSA?

An individual who is covered by such programs may still be eligible to establish an HSA if the programs do not provide significant medical care or medical treatment benefits. Certain screening and preventive care services are disregarded when determining whether a program provides significant medical care or treatment benefits.

Who May Contribute to an HSA?

Contributions to HSAs can be made by an eligible individual, the individual's employer, the individual's family members, and any other person. Contributions made by the individual are deductible from the individual's adjusted gross income. Contributions made by the individual's employer are excluded from the individual's income and are not taxable to the individual. Contributions from all sources are aggregated for purposes of applying the maximum annual contribution limit described below.

How Much Can You Contribute to an HSA?

The maximum contribution amounts are determined annually by the IRS (see IRS Publication 969 at www.irs.gov for details). These annual contribution limits apply regardless of whether the contributions are made by an individual, the individual's employer, the individual's family members, or any other person. The maximum contribution limits apply regardless of the deductible amount you purchased or when you opened the HSA qualified insurance plan, although you must maintain coverage for 12 consecutive months. The testing period rules and the recapture rules may apply.

Do Special Rules Apply to Contributions by Spouses?

HSA contributions by spouses are divided equally between them unless they have agreed to a different division.

What is the Federal Tax Treatment on an Eligible Individual's HSA Contributions?

Contributions to your HSA, up to the applicable maximum contribution, are deductible from your adjusted gross income, whether or not you itemize deductions.

What is the Federal Tax Treatment of Employer Contributions to an HSA?

Employer contributions to an employee's HSA are excludable from the employee's gross income, up to the maximum contribution limit for that employee. Although the employee cannot deduct the employer's HSA contributions, the contributions are not taxable to the employee nor are they subject to withholding from wages for income tax or other employment taxes. HSA contributions by employers are considered a type of benefit, and are therefore, tax-deductible for the employer.

Is there a catch-up contribution?

Individuals age 55 plus may make catch up contributions. The amounts are determined annually by the IRS (see IRS Publication 969 at www.irs.gov for details).

What if My Spouse Who is Also 55 Wishes to Make a Catch Up Contribution?

Your spouse may make a catch up contribution as well.

Is There a Deadline for Contributions to an HSA for a taxable year?

Contributions for any taxable year can be made in one or more payments, at any time prior to the deadline, without extensions, for filing your federal income tax return for that year, but not before the beginning of that year. For calendar year taxpayers, this deadline for contributions is generally April 15 following the year for which the contributions are made.

What Happens When HSA Contributions Exceed the Maximum Amount That May be Deducted or Excluded from Gross Income in a Taxable Year?

An "excess contribution" (a contribution made by you or your employer that exceeds the amount allowed by law) is not deductible by you or your employer and is included in your gross income if made on your behalf by your employer. An excise tax of 6% for each taxable year is imposed on excess individual and employer contributions. If the excess contributions for a taxable year and the net income attributable to such excess contributions are paid or distributed to you before the deadline (without extensions) for filing your federal income tax return for the taxable year, then the net income from the excess contributions are included in your gross income for the taxable year in which the distribution is received. However, the excise tax would not be imposed on the excess contributions nor would the distribution of the excess contributions be taxed. Allowable rollover contributions do not count in determining whether an excess contribution has been made.

Are Rollover Contributions to HSAs Permitted?

Rollover contributions from MSAs and other HSAs into an HSA are permitted. These rollover contributions to your HSA need not be in cash and are not subject to the annual contribution limits. Rollovers from an IRA are permitted once in a lifetime and cannot exceed the maximum contribution limits for that calendar year. Rollovers from a health reimbursement account ("HRA") or a health flexible spending account ("FSA") to your HSA are permitted up to 2011, and are in addition to the maximum contribution limits.

Can You Pledge Any Part of Your HSA as Security for a Loan?

Any portion of your HSA that you pledge as security for a loan will be treated as a distribution for the year the pledge is made. The amount pledged is includable in your gross income and a 20% premature distribution penalty tax on the pledged amount may also be imposed.

Do HSA Administration and Account Fees Count Toward the Maximum Annual Contribution Limit?

If such fees are paid directly to your HSA trustee or custodian by you or your employer, the fees are not considered contributions to your HSA and do not count toward the maximum annual contribution limit. If, instead, you authorize your HSA trustee or custodian to withdraw payment for such fees from your HSA, the amount withdrawn does not increase the maximum annual contribution limit. For example, if your maximum annual contribution limit is $2,000 and a $50 administration fee is withdrawn from your HSA, your annual contribution limit remains at $2,000. It does not increase to $2,050.

How Are HSA Contributions Treated for Tax/Payroll Purposes?

HSA contributions can be made pretax unless you are an individual or an employer who does not have a Section 125 Plan or Premium only Plan document that allows these dollars to be deducted on a pretax basis. Even in the event that one of the situations above is the case an HSA account holder can still make an HSA contribution post tax and then deduct it from their 1040 at the end of the year.

HSA contributions are entirely tax-free on a Federal basis in all states (whether those contributions are made by an employer or employee). At this time a hand full of states, including California do not follow Federal tax guidelines and State taxes still apply. Technically HSA contributions through a 125 cafeteria plan by salary reduction are treated as employer contributions - that is why they are excluded from income and wages. While most people consider salary reduction amounts as "employee contributions", technically, this is not the case - they are reported as employer contributions.

Salary reductions for health insurance are typically reported in box 12 - employees may need this information if State or local taxes do not exclude such amounts. Some employers may also include employer contributions to health insurance in box 12 so that employees know what they are receiving. A good HSA administrator will automatically issue tax documents to all account holders so they may add all HSA contributions onto their State tax return. Ultimately it is the account holder responsibility to report all HSA contributions and complete form 8889 if they had an HSA for the taxable year.

How are Distributions From an HSA Taxed?

Distributions from an HSA used exclusively to pay for the qualified medical expenses of you or your spouse or eligible dependents are generally excludable from gross income. The amount of any distribution not used exclusively for such qualified medical expenses is includable in your gross income and may be subject to an additional 20% premature distribution penalty tax on the amount includable. (This 20% penalty tax does not apply to distributions made after your death, disability, or attainment of age 65.) In addition, distributions made for expenses that are reimbursed by another health plan are includable in your gross income, whether or not the other health plan is a high-deductible health plan.

May a Mistaken Distribution Be Repaid Without Adverse Tax Consequences or Penalty?

The amount of a mistaken distribution is not included in your gross income nor is it subject to the 20% penalty or excise tax on excess contributions if: 1) you receive the distribution as a result of a mistake of fact due to reasonable cause and 2) you repay to your HSA the amount of the mistaken distribution no later than April 15 following the first year you knew or should have known of the mistake. (Please note that your HSA trustee or custodian is not obligated to allow you to repay mistaken distributions to your HSA.).

May Distributions From an HSA be Deferred to Later Taxable Years?

Distributions from your HSA to pay or reimburse qualified medical expenses incurred in the current year may be deferred to later taxable years, as long as those expenses were incurred after your HSA was established. Distributions from your HSA in the current year can be used to pay or reimburse qualified medical expenses incurred in prior years, as long as those expenses were incurred after your HSA was established. You must keep proper records in order for these distributions to be excludable from your gross income.

What Medical Expenses are Eligible for Tax-Free Distributions From Your HSA?

At present, qualified medical expenses include the following, but only to the extent these expenses are not covered by insurance or otherwise:

  • Abdominal supports
  • Abortion
  • Acupuncture
  • Air conditioner (when necessary for relief from difficulty in breathing)
  • Alcoholism treatment
  • Ambulance
  • Anesthetist
  • Arch supports
  • Artificial limbs
  • Autoette (when used for relief of sickness/disability)
  • Birth control pills (by prescription)
  • Blood tests
  • Blood transfusions
  • Braces
  • Cardiographs
  • Chiropractor
  • Christian Science Practitioner
  • Contact Lenses
  • Contraceptive devices (by prescription)
  • Convalescent home (for medical treatment only)
  • Crutches
  • Dental treatment
  • Dental x-rays
  • Dentures
  • Dermatologist
  • Diagnostic fees
  • Diathermy
  • Drug addiction therapy
  • Drugs (by prescription)
  • Elastic hosiery (by prescription)
  • Eyeglasses (by prescription)
  • Fees paid to health institute prescribed by a doctor
  • FICA and FUTA taxes paid for medical services
  • Fluoridation unit
  • Guide dog
  • Gum treatment
  • Gynecologist
  • Healing services
  • Hearing aids and batteries
  • Hospital bills
  • Hydrotherapy
  • Insulin treatment
  • Lab tests
  • Lead paint removal
  • Legal fees
  • Lodging (away from home for outpatient care)
  • Long term care insurance premiums
  • Medicare Parts A & B after age 65
  • Metabolism tests
  • Neurologist
  • Nursing (including board and meals)
  • Obstetrician
  • Operating room costs
  • Ophthalmologist
  • Optician
  • Optometrist
  • Oral surgery
  • Organ transplant (including donor's expenses)
  • Orthopedic shoes
  • Orthopedist
  • Osteopath
  • Oxygen and oxygen equipment
  • Pediatrician
  • Physician
  • Physiotherapist
  • Podiatrist
  • Postnatal treatments
  • Practical nurse for medical services
  • Prenatal care
  • Prescription medicines
  • Psychiatrist
  • Psychoanalyst
  • Psychologist
  • Psychotherapy
  • Radium therapy
  • Registered nurse
  • Special school costs for the handicapped
  • Spinal fluid test
  • Splints
  • Sterilization
  • Surgeon
  • Telephone or TV equipment to assist the hard-of-hearing
  • Therapy equipment
  • Transportation expenses (relative to health care)
  • Ultra-violet ray treatment
  • Vaccines
  • Vasectomy
  • Vitamins (by prescription)
  • Wheelchair
  • X-rays
  • Certain permissible premiums for dental insurance, accident, cancer and COBRA.

For more information, see IRS Publication 502: Medical and Dental Expenses (Section 213(d)) (PDF File).

How Does an HSA Work if My Employer Has a Healthcare FSA?

A group can offer health savings accounts (HSAs) along side a healthcare flexible spending account (FSA) as long as the group has a "limited purpose provision" added to their healthcare FSA plan document. This can be done by most healthcare FSA administrators. The "limited purpose provision" allows employees with a healthcare FSA to use their FSA funds "first dollar" for dental and vision - anything non medical, but the employee must use their HSA funds up to their annual deductible for medical before they can use their healthcare FSA funds for medical.

This rule also applies to employees whose spouses have an FSA with their employer even if the HSA account holder's employer does not offer a healthcare FSA. The limited purpose provision does not apply to those employees who do not have an HSA. Without the limited purpose provision added to the healthcare FSA plan document, an employee with a healthcare FSA cannot have an HSA. A dependent care FSA is not affected by the addition of an HSA. IRS Publication 969 (www.irs.gov) covers the Healthcare FSA/HSA stacking rules and "limited purpose provisions" on a high level.

Can HSA Funds Be Used for a Domestic Partner?

HSAs are a Federal program and as such covered by Family Protection Act which does not recognize domestic partnerships even if the state of residency does. In the state of California for example, an employee's domestic partner could be covered under the employee's health plan however, the employee can only make a single HSA contribution (assuming there were no children). In such a case, the employee cannot use his/her HSA funds for the domestic partner's expenses (even if qualified) without being taxed and penalized. The only way for a domestic partner to be a recognized for Federal tax purposes is if the partner qualifies to be a legal tax dependent. Or, the domestic partner can open up their own HSA bank account.

What Information Must Be Reported to the IRS?

We report contributions and disbursements to the IRS. Those reports are also given to the account-holder in Form 5498SA (yearly contributions) and Form 1099SA. The HSA's Administrator's fourth quarter report will help account-holders complete form 8889, which is filed with your annual tax return. Forms 5498SA and 1099SA are required by the IRS (May 31 and February 28, respectively.)

I'm Leaving My Employer, Can I roll my HSA Funds into an IRA?

You cannot roll the HSA funds over into an IRA. They will stay in the HSA or be rolled into another HSA. You can withdraw funds from your HSA account, pay applicable taxes (and penalties) on the amount you withdraw, and then use the remaining funds to make a contribution to your IRA. However, the amount you contribute to your IRA is still limited by the annual contribution limits.