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HSAs seem destined for success, problems and all
Health saving accounts have been slow to catch on. Despite glowing praise from administration officials, and even the president on several occasions, HSAs have been under-subscribed.
Nevertheless, their time will come, since HSAs have clearly been designed to provide definite advantages to a broad range of employers, employees and self-employed individuals.
HSAs have been available since Jan. 1, 2004. They provide upfront deductions, tax-free deferral of earnings and tax-free distributions. In fact, HSAs represent the first opportunity for most individuals to get an upfront deduction for contributions to a tax-deferred vehicle and then escape income tax on the distribution of those contributions and earnings. The policy reason behind this beneficence is to encourage patients to be price-conscious consumers of medical services.
There are several reasons for HSAs’ slow start.
The enabling legislation was signed only last December. Banks, insurance companies and other potential trustees have had scant time to ramp up their paperwork to offer them to the public. Most individuals who have been approaching their bank or broker to set one up have not gotten very far. Only a few insurance companies that had been handling medical savings accounts were prepared.
Finally, the rules themselves are not only complicated, but also vague on a number of counts. Questions are arising as to how the requirements for HSAs and their related high-deductible health plans relate to real-life health benefits actually being offered in the marketplace.
Now or later?
The IRS took a stab at clarifying the rules earlier this year, and has promised more guidance by June. Nevertheless, many practitioners are assuming that, with almost half the year gone, the time for setting up HSAs for 2004 has passed.
Under normal circumstances, the maximum amount allowed to be contributed to an HSA is determined pro rata by month. However, to help jump-start HSAs, Notice 2004-24 provides that, as long as the HSA is established by April 15, 2005, it may be used to pay for qualified medical expenses incurred in calendar year 2004.
For 2004 only, maximum contributions will be determined based on the months in which the high-deductible plan is in place, not when both the HDHP and the HSA are in existence. On an annual basis, contributions are allowed up to the lesser of 100 percent of the annual deductible or $2,600 ($5,150 for family coverage), plus an extra $500 catch-up contribution for individuals age 55 or older.
For 2004 and 2005 only, the Internal Revenue Service also removed another roadblock to setting up an HSA. Some employers had set up HSAs under the assumption that prescription drug benefits, like vision and dental care, routine physicals and the like, were exempt from the high-deductible limit. Others have been holding back on HSAs under the opposite assumption. While the IRS clarified that prescription drugs are not generally exempt for the overall high deductible, it announced in Notice 2004-23 a “transition rule” that makes them exempt for 2004 and 2005.
Spouse as family
For 2004, a qualifying HDHP is one with an annual deductible of at least $1,000 for individual coverage or $2,000 for family coverage. “Family,” for this purpose, includes spouses, even in situations without children. This definition unfortunately leads to a marriage penalty that will impact whether some couples should opt for an HSA.
Many policies today require a per-person deductible but set the family deductible as the cap after which no deductible is imposed for other family members. Under the HSA rules, however, the HSA owner and his spouse in combination must reach the $2,000 level before any medical expense is reimbursed.
For example, a married owner with $1,400 in medical expenses cannot be reimbursed by an HDHP at all, while a single owner would be entitled to $400 as qualified for reimbursement.
Another downside of being one “family” involves the minimum amount considered as the deductible in qualifying the plan as an HDHP. If both spouses are covered by plans, the one with the lowest family deductible determines whether either is qualified for an HSA.
Conclusion
As had been the case with new Roth IRAs after the 1997 Tax Act, the rules for HSAs are taking a while to work out. While this confusion justifiably has some taxpayers sitting on the sidelines for the moment, HSAs, like the Roth IRA, appear to be here to stay.
Predictably, those taxpayers most in need of medical services on a continuing basis for chronic illnesses will not fare as well under the HDHP/HSA combination as they have under tradition health plans. Nevertheless, marketplace pressures for viable medical insurance alternatives continue to increase as premiums continue to outpace inflation.
HDHP/HSAs can lower, or at least hold down, medical insurance costs for many employers while keeping most employees reasonably satisfied with the result. The lure to some workers of “hitting the jackpot” by being able to roll over HSA contributions in a significant nest egg because of good health will help their acceptance.
May 2004
Health saving accounts have been slow to catch on. Despite glowing praise from administration officials, and even the president on several occasions, HSAs have been under-subscribed.
Nevertheless, their time will come, since HSAs have clearly been designed to provide definite advantages to a broad range of employers, employees and self-employed individuals.
HSAs have been available since Jan. 1, 2004. They provide upfront deductions, tax-free deferral of earnings and tax-free distributions. In fact, HSAs represent the first opportunity for most individuals to get an upfront deduction for contributions to a tax-deferred vehicle and then escape income tax on the distribution of those contributions and earnings. The policy reason behind this beneficence is to encourage patients to be price-conscious consumers of medical services.
There are several reasons for HSAs’ slow start.
The enabling legislation was signed only last December. Banks, insurance companies and other potential trustees have had scant time to ramp up their paperwork to offer them to the public. Most individuals who have been approaching their bank or broker to set one up have not gotten very far. Only a few insurance companies that had been handling medical savings accounts were prepared.
Finally, the rules themselves are not only complicated, but also vague on a number of counts. Questions are arising as to how the requirements for HSAs and their related high-deductible health plans relate to real-life health benefits actually being offered in the marketplace.
Now or later?
The IRS took a stab at clarifying the rules earlier this year, and has promised more guidance by June. Nevertheless, many practitioners are assuming that, with almost half the year gone, the time for setting up HSAs for 2004 has passed.
Under normal circumstances, the maximum amount allowed to be contributed to an HSA is determined pro rata by month. However, to help jump-start HSAs, Notice 2004-24 provides that, as long as the HSA is established by April 15, 2005, it may be used to pay for qualified medical expenses incurred in calendar year 2004.
For 2004 only, maximum contributions will be determined based on the months in which the high-deductible plan is in place, not when both the HDHP and the HSA are in existence. On an annual basis, contributions are allowed up to the lesser of 100 percent of the annual deductible or $2,600 ($5,150 for family coverage), plus an extra $500 catch-up contribution for individuals age 55 or older.
For 2004 and 2005 only, the Internal Revenue Service also removed another roadblock to setting up an HSA. Some employers had set up HSAs under the assumption that prescription drug benefits, like vision and dental care, routine physicals and the like, were exempt from the high-deductible limit. Others have been holding back on HSAs under the opposite assumption. While the IRS clarified that prescription drugs are not generally exempt for the overall high deductible, it announced in Notice 2004-23 a “transition rule” that makes them exempt for 2004 and 2005.
Spouse as family
For 2004, a qualifying HDHP is one with an annual deductible of at least $1,000 for individual coverage or $2,000 for family coverage. “Family,” for this purpose, includes spouses, even in situations without children. This definition unfortunately leads to a marriage penalty that will impact whether some couples should opt for an HSA.
Many policies today require a per-person deductible but set the family deductible as the cap after which no deductible is imposed for other family members. Under the HSA rules, however, the HSA owner and his spouse in combination must reach the $2,000 level before any medical expense is reimbursed.
For example, a married owner with $1,400 in medical expenses cannot be reimbursed by an HDHP at all, while a single owner would be entitled to $400 as qualified for reimbursement.
Another downside of being one “family” involves the minimum amount considered as the deductible in qualifying the plan as an HDHP. If both spouses are covered by plans, the one with the lowest family deductible determines whether either is qualified for an HSA.
Conclusion
As had been the case with new Roth IRAs after the 1997 Tax Act, the rules for HSAs are taking a while to work out. While this confusion justifiably has some taxpayers sitting on the sidelines for the moment, HSAs, like the Roth IRA, appear to be here to stay.
Predictably, those taxpayers most in need of medical services on a continuing basis for chronic illnesses will not fare as well under the HDHP/HSA combination as they have under tradition health plans. Nevertheless, marketplace pressures for viable medical insurance alternatives continue to increase as premiums continue to outpace inflation.
HDHP/HSAs can lower, or at least hold down, medical insurance costs for many employers while keeping most employees reasonably satisfied with the result. The lure to some workers of “hitting the jackpot” by being able to roll over HSA contributions in a significant nest egg because of good health will help their acceptance.
May 2004
