Looking for a way to reign in health insurance costs? The Health Savings Account (HSA) may be just what you’re looking for. Established under the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 the intention was to replace the Archer Medical Savings Accounts (MSA) scheduled to expire at 12/31/03. Archer MSA’s were extended and now co-exist with the HSA. The HSA saves health cost premiums by using a high deductible health policy (HDHP) to cover major health costs. Health costs, up to the deductible amount, are covered out of contributions made to the HSA.

Some advantages of the HSA include: tax free earnings; a tax deduction for contributions without itemizing; tax free distributions for qualified medical expenses; unused contributions can remain in the account until needed; the HSA belongs to the individual even through job changes; distributions can be used after retirement as an IRA supplement.

The HSA is a tax-exempt trust or custodial account established with a qualified HSA trustee. It is very similar to an IRA. Distributions are made from the account to pay for medical expenses not covered by your HDHP. As long as you meet eligibility requirements you can establish a HSA. There is no permission or authorization from the IRS needed. You work directly with a trustee to set up the account. The trustee can be a bank, an insurance company or anyone approved by IRS to handle IRAs or Archer MSA's. You are not required to use your HDHP provider to establish your HSA

HSA's can be established by individuals for their own use (no joint accounts) or by employers to provide health benefits to their employees. (Each employee has his or her own account.) To qualify you must:

In order to qualify as a HDHP (high deductible health policy) the minimum annual deductible must be at least $1,000 and not more than $5,000 for self-only and at least $2,000 but not more than $10,000 for family coverage. If a policy uses a network of providers the maximum deductible does not apply to out of network providers.

Example

An eligible individual and his dependent child are covered under an “employee plus one” HDHP offered by the individual’s employer. This is family HDHP coverage.

You can have no other health coverage other than a HDHP; however, you may have coverage either under your HDHP or under a separate policy if it is for permitted coverage. Permitted health coverage that is not a HDHP may include:

Workers’ Compensation, tort liability, or liability related to property ownership or use.

If a plan provides only for the above or any of the above listed coverages then it is not a HDHP for purpose of establishing a HDHP. Prescription drug coverage, after 2005, whether under a HDHP or separate policy, must not pay benefits until the deductible is met.

Generally if a Flexible Spending Arrangement (FSA) or a Health Reimbursement Arrangement (HRA) covers an employee you are not eligible for a HSA. There are some exceptions of course. If the FSA or HRA are limited in purpose, suspended, for post deductible expenses, or only apply after retirement, an individual may still establish a HSA.

Once you are eligible for an HSA, contributions can be made as an individual, or by your employer or both in the same year. In addition any other person or family member may make contributions on behalf of an eligible individual. Contributions must be in cash; stocks or property is not a permitted contribution. Contributions are limited to the deductible amount on your HDHP but, for 2004 & 2005, not more than $2,600 for self-only coverage and $5,150 for family coverage. These amounts are for the entire year. If you only have coverage for a portion of the year you must prorate the amounts for the portion of the year you are an eligible individual. IRS provides worksheet for line 3 of form 8889 to determine this amount. If you are 55 or older you may increase your limits by $500 for 2004 and $600 for 2005.

The contribution limits are per individual or family not per HSA. You may have more than one HSA but the limits apply to all of your accounts combined. The limits must be reduced by any contributions made by you or your employer to an Archer MSA for the year. In addition you must reduce the contribution you or anyone can make to your HSA by the contribution made by your employer and excluded from your income.

For married individuals having family coverage both spouses are treated as having family coverage. If each spouse has family coverage under a separate plan, both are treated as having family coverage under the plan with the lower annual deductible. The contribution limit is reduced by amounts contributed to both spouses Archer MSA. The balance can be split equally between the spouses or in any division agreed upon.

You can rollover amounts from Archer MSA’s and other HSA’s into a HSA. Rollover contributions do not need to be in cash. Rollovers are not subject to the annual contribution limits. You must roll over the amount within 60 days after the date of receipt. You can make only one rollover contribution to a HSA during a 1year period. Rollovers from an IRA, HRA or a FSA into a HSA are prohibited.

You may deduct contributions made for the tax year by you or any one contributing on your behalf, except your employer, as an adjustment to gross income by using form 8889. Contributions made by your employer are already excluded from your income. Contributions to a HSA can be made up to April 15^th of the following year. Form 8889 allows you to calculate your above the line tax deduction for contributions made to your HSA. You should receive Form 5498-SA, HSA, Archer MSA, or Medicare+Choice MSA information, from the trustee showing the amount contributed during the year. Your employer contributions also will be shown in box 12 of Form W-2, Wage and Tax Statement, with code W. Follow the instructions for Form 8889 and report your HSA deduction on Form 1040 line 28.

If you do not pay attention to the contribution limits and make an excessive contribution it is not deductible. If your employer makes an excessive contribution it should be included in your Gross income on your W-2. If it is not you must report the excess on line 21 of Form 1040 as Other Income. A 6% excise tax is imposed on excess contributions that are not withdrawn by the due date of the tax return including extensions. When you withdraw excess contributions you must also withdraw excess earnings. The excess earnings withdrawn are taxed in the year they are withdrawn.

As you incur and pay medical expenses during the year you may ask for distributions from your HSA until you reach your deductible in your HDHP. The distributions from the HSA are tax free when used to pay or reimburse medical expenses incurred after you establish your HSA. If you receive distributions for any other reason the amount you withdraw is subject to income tax and may also be subject to an additional 10% tax. You are not required to make annual distributions from your HSA. If you are no longer an eligible individual, you may still receive tax-free distributions to pay or reimburse your qualified medical expenses. A distribution is any money you receive from your HSA. The trustee will report any distributions to you and the IRS on Form 1099-SA, Distributions From an HSA, an Archer MSA, or Medicare+Choice MSA.

You may pay or reimburse any Qualified Medical Expenses, which are those expenses that would generally qualify for the medical and dental expense deduction. These are explained in IRS Pub 502, Medical and Dental Expenses. Examples include amounts paid for doctors’ fees, prescription medication, and necessary hospital services not paid for by insurance. Qualified medical expenses are those incurred by you, your spouse, and your dependents. You cannot deduct qualified medical expenses as an itemized deduction on Sch A (Form 1040) that are equal to the tax-free distribution from your HSA.

Generally you cannot pay health insurance premiums out of your HSA however, you may use your HSA to pay for long-term care coverage, health care coverage if you are receiving unemployment benefits, or health care continuation coverage required under any federal law. If you are age 65 or older, you can treat insurance premiums (other than premiums for a Medicare supplemental policy, such as Medigap) as qualified medical expenses for HSA’s. Long-term care premiums are subject to the limits under sec 213(d)(10). These limits are based on age and are adjusted annually.

The distributions were used exclusively to pay or reimburse qualified medical expenses,

The qualified medical expenses had not been previously paid or reimbursed from another source, and

Do not send these records with your tax return. Keep them with your tax records.

The balance in you HSA at your death will go to your designated beneficiary. A spouse can continue to use the HSA. A non-spouse beneficiary will be taxed on the balance inherited.

For more information see IRS Publication 969 (http://www.irs.gov/publications/p969/ar02.html)

In Pennsylvania the state House unanimously approved legislation the week of 5/23/05 that would make Health Savings Accounts (HSA’s) more tax-friendly for Pennsylvanians. The bills now move on to the Senate for consideration.

House Bill 107, sponsored by Rep. John Payne (R-Dauphin), would provide deposits to health care savings accounts the same tax advantages now granted only to health insurance premiums. It would allow individuals to control some of their own health care dollars without a tax penalty.

House Bill 734, sponsored by Rep. Scott Boyd (R-Lancaster), offers a tax credit to employers based on the amount of money they contribute to an employee's HSA. The tax credit would be offered at two different levels: 50% of the amount contributed on behalf of the employee, spouse and dependants; or, 25% of the amount contributed on behalf of the employee alone.

Since the inception of HSA’s in December of 2003, the federal government made deposits and withdrawals on these accounts free of federal taxes. The money, however, is still subject to state income tax unless the state uses the federal definition of income or enacts legislation that exempts the accounts from state income tax.