Health Savings Accounts Gaining Popularity

We are observing increased usage of Health Savings Accounts (HSAs), either as an option in connection with employer-sponsored medical insurance plans or by self-employed individuals. Essentially, HSAs involve a deductible (if paid by the employee or self-employed person) or nontaxable (if paid by the employer) contribution to the HSA, a tax-free buildup of earnings on the HSA funds, and no tax consequences when distributions are made from the HSA (as long as the distributions are used to fund what otherwise would be deductible medical expenses). In some respects, HSAs operate much like a qualified retirement plan in that the initial funding is either deductible or tax-free and the earnings on the funds contributed are nontaxable, but in the case of HSAs the eventual payment of medical expenses is nontaxable to the account owner. Considering the nondeductibility of medical expenses unless they exceed 7 _ % of adjusted gross income (for regular tax, 10% for alternative minimum tax), the use of HSAs allows those limitations to be avoided and for medical expenses to be paid with pre-tax dollars. In some respects HSAs also are similar to a flexible spending account arrangement, except the earnings on the HSA account are nontaxable, and any HSA balance at the end of the year remains in the account even if unspent for that year. HSAs may be viewed as being tax-favored savings accounts for medical expenses.

Who may participate in HSAs? First, the participant must be covered by a high-deductible health plan (HDHP). For 2007, a HDHP is one with a minimum deductible for single coverage of $1,100 and for family coverage of $2,200. Under such a plan the maximum out-of-pocket is limited to $5,500 for single coverage and $11,000 for family coverage. The amounts shown are for 2007; these amounts are subject to annual inflation adjustments. Once HSA owners attain age 65, no further contributions can be made to the HSA. However, distributions for qualified medical expenses continue to be excludable from gross income after the account owner attains age 65. HSA account owners cannot be covered by health insurance other than a HDHP.

Unlike flexible spending accounts, HSAs belong to the owner and are portable. As a result, for an employer-sponsored plan, if the employee changes jobs, the account still belongs to the individual and can be used to fund future medical expenses.

Contributions to an HSA for 2007 are limited $2,850 for single coverage and $5,650 for family coverage. A catch-up provision for individuals who have reached age 55 by the end of the tax year increases the contribution limit by $800 for 2007, $900 for 2008, and $1,000 for subsequent years. Excess contributions are subject to a 6% excise tax and are includable in gross income. If the employer contributes to an employee HSA, the contribution is treated as employer-provided health insurance coverage, resulting in it being excluded from taxable income, FICA, and FUTA.

Distributions from HSAs are tax-free as long as they are used to pay for qualified medical expenses. If used for other purposes, the distributions are taxable and a 10% penalty applies. The HSA can pay for spouse and dependent medical expenses, even if they are not covered by the HDHP. HSA distributions can be used to fund any out-of-pocket qualifying medical expenses, including deductibles and co-pays. HSA distributions can be made at any time for medical expenses incurred after the effective date of the HSA; they do not have to be made in the year the medical expense is incurred.

If you have not considered HSAs either for your company or individually, we suggest that you give these accounts consideration. Please contact us if you would like to know more about HSAs.