Health Savings Accounts

The Health Savings Account (HSA) – The Dawning of Expanded Health Care 

By Paul M. League, QFP, CFP® [www.LeagueFinancial.com] - May 2004

President George W. Bush signed into law the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 on December 8, 2003.  Tucked along with it comes the January 2004 enactment of the Health Savings Account (“HSA”), created for persons prior to reaching Medicare age, typically age 65, and created to help one save to meet medical and retiree health expenses on a tax-free basis. 

According to a statement by Treasury Secretary Snow on 12/9/03: 

“An important provision in the bill greatly expands the former Medical Savings Accounts into new and innovative Health Savings Accounts.  HSAs provide an important and welcome option for many Americans to fund their health care expenses.  Treasury is committed to ensuring that taxpayers get the full benefit of HSAs as quickly as possible”. 

What is an HSA? 

Like its precursor MSA, or Medical Savings Account, the HSA is a two-component health plan consisting of a tax-deductible, high deductible catastrophic health insurance plan, and a tax-free claims expense reimbursement and tax-deferred savings plan. 

Reimbursements from the savings plan account, for those expenses deemed eligible (as defined under a more liberal and far broader federal definition) are received 100% tax free, while all other withdrawals are taxable as ordinary income with an added penalty when taken prior to age of 65. Simply stated, the HSA is just the permanent expansion of the former MSA, but with several very meaningful enhancements. 

Why an HSA, or Health Savings Account?

The primary reason is affordability, and the secondary open choice in doctors and hospitals.  Many vendors of the precursor MSA required insureds to use only network-listed doctors and hospitals, making them much like the less desirable and restrictive HMO (Health Maintenance Organizations with their Staff Models or IPAs – Independent Physician Associations), or the slightly less restrictive PPO (Preferred Provider Organizations).  The reason they did so is because such networks provide Insurers with pricing discounts that “may” be passed onto the consumer, either by increased benefits, lower policy premiums, or both. 

Like these former MSA models there will also be versions of the new HSA offering discounted network-linked models; however, a significant advantage of an HSA that’s, “made of the right stuff”, is one that places no such restrictions on an insureds freedom to seek out and negotiate services from any doctor or any hospital of their choosing.  However, for this to work out properly, there needs to be an incentive to cost control.  Therefore, on the cost side of the equation, only when consumers have a good portion of their assets at stake will they be compelled to shop for and receive more cost effective and reasonably priced health care.  This will mean higher first dollar deductibles, which conveniently will cause the consumer to think before spending, thereby helping to dampen spending and the associated higher costs.  After all, who really needs to pay the high costs of medical insurance for an occasional, and relatively low cost check up, cold or flu?  What is really needed by all is coverage that handles the more costly, catastrophic health care costs associated with surgery, hospitalization and chronic health conditions. 

Government and health Insurers, have proven to be largely ineffective in controlling long-term health care costs, until perhaps now.  Enticing consumers into zero, or very low co-pay HMOs or low deductible PPOs, has only wrongly reinforced the consumer misconception of the health care Medical Insurance ID Card and plan as equal to a “credit card”…but with one slight of hand; namely, that it is a one way proposition supported by, and paid for by, some fat-cat Insurer paying for all consumer excesses.  Little did consumers know, until perhaps having passed through the last decade where premiums & health care costs have again reached all time highs, that all of this spending has come back with a fury to bite them in the form of reduced benefits, more cost shifting by the Insurers, and increased out of pocket expenses at the premium gas pump!  Indeed, the piper has returned and is seeking inflation-adjusted payment.  With cost increases once again averaging in excess of 12-20% annually, under most any health plan model, one can easily see the immediate need for a timely, longer-term solution and alternative to the present highway-to-ever-increasing-health-care-costs system. 

HSAs to the rescue! 

MSAs, with limited carriers who actually understood the model, have proven stable and able to control long term costs more effectively then their HMO, PPO, EPO, or other such cost-containment model counterparts. One such MSA carrier reports an industry breaking 80% policyholder persistency, with rate renewals way under their US counterparts, and they (and the few others like them), are ready to go with enhanced, and now permanently expanded, new HSA models. 

The HSA Enhancements 

With the permanent expansion of MSAs into HSAs, come a number of key improvements and advantages over all prior and parallel existing models, of all types, for example: 

First, and foremost, now anyone can have an HSA.
Premiums, for the catastrophic health insurance component, are 100% tax deductible to those who are self-employed, although this is under consideration to be expanded to cover all persons.
Personal contributions into the Health Savings Account component are 100% tax deductible for all individuals, whether or not they are self-employed, Partners or S-Corporation owners (the only ones who were eligible under the prior MSA models), and such deposits accumulate tax-deferred.
HSA savings account contributions may be made each year up to 100% of the policy deductible.  So, a $5,150 deductible, the highest available family deductible for 2004, can be fully deducted, unlike the precursor MSA, where a single person could previously only tax deduct up to 65% of their deductible, or 75% for parties of two or more (Family).
Individuals ages 55-65 may make additional "catch-up" contributions of up to $500 in 2004, increasing to $1,000 annually in 2009 and thereafter.  A married couple can make two catch-up contributions as long as both spouses are at least age 55.
New lower deductible limits have been introduced for Single $1,000, and Family of $2,000 (these newer lower deductible plans will cost more, and also do not provide the needed tax savings to make the HSA pricing equation work well, although they will help to interest virgin newcomers into looking into HSAs).
New deductible limits will be tied to the Consumer Price Index (CPI) starting January 1, 2004 onward. 

New 2004 Deductibles (indexed annually for inflation):

• New out of pocket maximums (includes deductibles and all co-pays and/or co-insurance expenses) of $5,000 Single, and $10,000 for 2 or more (Family).  Initially, most plan designs will not even come close to these higher out-of-pocket caps, but over time, as a way of offsetting premium increases, they will.
• The broader federal definition of “eligible medical expense” remains and therefore includes, and allows for tax free reimbursements on such often non-covered or substantially reduced items of traditional health plan models of any given State, as: Dental, Vision, Chiropractic, Mental, Long Term Care services and insurance premiums, COBRA, etc.
• Preventive care services, as well as coverage for accidents, disability, dental care, vision care, and long-term care are not subject to the deductible, so they can be paid as "first dollar benefits", and reimbursed 100% tax free from the savings component of the HSA.
• The penalty for taking withdrawals for other then tax free reimbursement of eligible medical expenses from the Savings component is reduced from the MSA penalty of 15% down to only 10% for the HSA.
• HSA contributions may be made by individuals, family members and employers and are tax deductible, even if the account beneficiary does not itemize.  Employer contributions are made on a pre-tax basis and are not taxable to the employee. Any savings account contributions by the employer are not subject to payroll tax (therefore not subject to State or Federal withholding, or Medicare or FICA).
• Reimbursements from the HSA Savings Account component, for eligible medical expenses, remain tax free, and also do not require that one exceed 7.5% of their AGI threshold (Adjusted Gross Income) to qualify.
• Employees can use their Section 125 Cafeteria Plan funds to pay for their HSA insurance premiums, thereby using pre-tax Cafeteria Plan dollars over after-tax dollars.  Generally, employees would make payments to the savings component of the HSA with non-Section 125 funds.
• HSAs are fully portable by employees.
• HSA savings may also be used to pay for Medicare premiums, or the cost of a Medicare HMO, but can not be used to buy supplemental insurance that is designed to pick up the gaps in Medicare, better known as Medi-Gap policies.
• Upon death, HSA ownership may transfer to the spouse on a tax-free basis.

While many will be attracted by the new lower deductibles, once priced out, they will soon realize that the higher deductibles continue to afford the “better buy”.  Why?  As with the prior MSA, the HSA finds its additional sizzle within the tax deduction side of the equation.  With the higher deductible, and higher out of pocket plan maximums (i.e. a combination of deductibles along with all insured co-insurance & co-pay liabilities) of $5,000 for a single and $10,000 for 2 party or family, and especially for those in higher tax brackets in need of tax deductions, the result can be the government subsidizing up to 100% of the health insurance premium component of your plan.  The way this occurs is one may receive more in direct tax deductions, again depending on ones tax bracket, then the cost of the high deductible, high out of pocket, catastrophic health insurance itself that forms the foundation of the HSA.  Under such scenarios, it may be preferable, and much cheaper, to simply run all health expenses through a tax deductible HSA savings account, where reimbursements are also received tax-free. 

For Group HSAs, many Insurers will continue only selling “List Billed” programs, so that they can avoid the guarantee issue requirements of many State small group insurance laws (like California's AB 1672).  Employees, whose employers set up and fund an HSA, can’t deduct the health insurance premium (though they could move it to pre-tax using a Cafeteria Section 125 Plan), but can deduct the savings account (that money that is earmarked for 100% funding of their HSA plan deductible) to whatever extent they share in its funding.  Many employees may even prefer that the employer and/or themselves fund the savings component of the HSA with “after-tax” dollars (i.e. neither will declare a tax deduction), so as to not have any of that money "locked up" by the pre-65 penalties, regardless of who contributed what.  Certainly, owners and key personnel will want the full advantages of tax deductibility and deferred savings, though rank and file employees may fair better buying their own, private, HSA, with or without employer support.  Remember too, that HSAs are fully portable, yet another advantage to owning one.

HRAs, or Health Reimbursement Arrangements, and Cafeteria Section 125 Flexible Spending Accounts (FSAs) both with reversion of unused medical expense dollars back to the Employer, will now become increasingly challenged, and, in the case of HRAs, less undesirable.  Why?  Well, employees will see the advantages in HSAs over HRAs where they maintain control of their savings account dollars, and where they can also access such “assets” for other then medical expenses (albeit at a penalty prior to age 65, only when withdrawn for other then eligible medical expenses), rather then having them “sacrificed” or reverted back to their employer when not fully used up for eligible medical expenses.  No more lack of portability or of the “Use It or Loose It” forfeitures problems. 

The Health Savings Account is indeed a welcome expansion of health care, a timely solution that will bring forth years of creative options for American health care consumers.  No longer a trial program, like its precursor MSA, many Insurers will finally make the investment in both infrastructure and plan design, ramping up with a myriad of meaningful consumer offerings that will increase competition and choice for all.  Will the HSA, in addition to providing important increased health care options, also end up better controlling costs?  This remains to be seen, but the answer lies more likely in the consumers understanding, embrace, and utilization of the core features & characteristics that position the HSA with the ability to be distinctly better than most any other health care model heretofore available.

Disclaimer Notes: The material discussed is meant for general illustration or informational purposes only and is not to be construed as investment or tax advice. Although the information has been gathered from sources believed to be reliable, it is not guaranteed. Please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice. We do not provide tax or legal advice]. ©Paul M. League. All Rights Reserved. 

Author: Paul M. League, QFP, CFP® is the principal of League Financial & Insurance Services / LeagueFinancial.com, and Chairman of the INTERNATIONAL ASSOCIATION of QUALIFIED FINANCIAL PLANNERS (www.IAQFP.org). Paul has specialized in wealth creation, preservation, and expansion through individual and group benefit programs for over 20 years. He can be reached at 332 S. Beverly Drive, Suite #101, Beverly Hills, CA 90212, phone (310) 277-3141; www.TheHealthSavingsAccount.com; www.LeagueFinancial.com; E-mail: Paul@LeagueFinancial.com.

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