Are You in a Health Plan With a High Deductible?
Kegler Brown Estate Planning + Probate Newsletter March 1, 2004
New Health Savings Accounts Can Help
As the cost of healthcare increases, individuals and employers continue to look for methods to reduce the cost of healthcare. If healthcare is provided through insurance, premiums can be reduced by increasing the amount which must be paid by the individual as a deductible before reimbursement commences, or by lowering the amount which will be paid by the insurance company for out of pocket expenses incurred by the individual. New legislation, effective January 1, 2004, has been enacted to provide tax-favored treatment for amounts that are contributed to a Health Savings Account and are used to pay medical expenses for the benefit of the account owner. The Internal Revenue Service in Notice 2004-2 has provided guidance for establishing Health Savings Accounts, summarized as follows:
A. Health Savings Accounts
A Health Savings Account (HSA) is a tax-exempt trust or custodial account which is established exclusively for the purpose of paying qualified medical expenses of the beneficiary of the account. An HSA, as established for the benefit of an individual, is owned by that individual and is portable so that the HSA remains the property of the employee even if the employee changes employers or leaves the workforce. Contributions made to an HSA by an eligible individual are deductible by the individual in determining adjusted gross income and, therefore, are deductible whether or not the individual itemizes deductions. If an employer makes contributions to an HSA for an employee, the amount contributed is excluded from the gross income of the employee. The employer contributions are not subject to income tax withholding or FICA or FUTA tax. The HSA is exempt from tax as long as it is an HSA, so that earnings on amounts in an HSA are not included in gross income while in the HSA. Distributions from an HSA used exclusively to pay for qualified medical expenses of the account beneficiary, the beneficiary's spouse, or dependents are excludable from gross income. Any amount of the distribution not used exclusively to pay for qualified medical expenses is includable in gross income and is subject to an additional 10% tax on the amount includable, unless made after the beneficiary's death, disability, or attaining age 65.
B. Individuals Eligible to Establish an HSA
An HSA can be established by an "eligible individual." Eligibility is determined on a monthly basis. An eligible individual is a person who: (1) is covered under a high-deductible health plan, which is a plan with an annual deductible of at least $1,000 for self-only coverage and which pays annual out-of-pocket expenses in amounts which do not exceed $5,000 (for family coverage, the annual deductible is $2,000 and the out-of-pocket limit is $10,000); (2) is not also covered by any other health plan that is not a high-deductible health plan; (3) is not entitled to benefits under Medicare; and (4) may not be claimed as a dependent on another person's tax return.
C. How to Establish an HSA
An eligible individual can establish an HSA with a qualified HSA trustee or custodian, similar to establishing a qualified IRA. No permission or authorization from the IRS is necessary to establish an HSA, and an eligible individual who is an employee may establish an HSA with or without involvement of the employer. The HSA trustee or custodian must be an insurance company, a bank or any person previously approved by the IRS to be a trustee or custodian of an IRA. You can check with your bank or insurance company for information as to establishing an HSA.
D. Contributions to an HSA
Contributions may be made to an HSA established by an individual employee by the employee, the employer of the employee, or both the employee and the employer. Family members may also make contributions to an HSA on behalf of another family member if that other family member is an eligible individual. There is a limit as to the amount that can be contributed to an HSA on an annual basis. Although the maximum contribution is an annual amount, the amount is determined separately for each month, determined as of the first day of each month. For 2004, the maximum monthly contribution for eligible individuals with self-only coverage is 1/12 of the lesser of (a) 100% of the annual deductible under the high-deductible health plan, or (b) $2,600. For eligible individuals with family coverage under a high-deductible health plan, the maximum monthly contribution is 1/12 of the lesser of (a) 100% of the annual deductible under the high-deductible health plan, or (b) $5,150. However, there is an additional benefit for individuals age 55 or older and younger than 65, who can increase their maximum contribution by $500 in 2004. This catch-up amount will increase in $100 increments annually, until the catch-up amount reaches $1,000 in 2009. After an individual has attained age 65, contributions, including catch-up contributions cannot be made to an individual's HSA. Contributions to an HSA must be made in cash.
E. Distributions From an HSA
An individual is permitted to receive distributions from an HSA at any time. The distributions receive tax-favored treatment as described above, as long as the distributions are for "qualified medical expenses." Qualified medical expenses are expenses paid by the account beneficiary, his or her spouse or dependents for medical care as defined in §213(d) of the Internal Revenue Code, but only to the extent the expenses are not covered by insurance or otherwise. The qualified medical expenses must be incurred only after the HSA has been established. Medical expenses paid from an HSA cannot be claimed as an itemized deduction for medical expenses on the individual's federal income tax return.
If the account beneficiary is no longer an eligible individual (e.g., the beneficiary is over age 65 or no longer under a high-deductible health plan), distributions used exclusively to pay for qualified medical expenses continue to be excludable from gross income. Any distribution not used exclusively to pay for qualified medical expenses of the account beneficiary, spouse or dependents is taxable income and subject to the additional 10% tax, as discussed above. The determination as to whether HSA distributions are used exclusively for qualified medical expenses is made solely by the individual account beneficiary, who should maintain records sufficient to prove that the distributions have been made exclusively for qualified medical expenses. An HSA trustee or custodian, or an employer who makes contributions to an employee's HSA, is not required to determine if the distributions are used exclusively for qualified medical expenses. If an individual dies with a balance remaining in an HSA, the account balance becomes the property of the person named in the HSA as the beneficiary of the account. If the individual named is the account beneficiary's surviving spouse, the HSA becomes the HSA of the surviving spouse. The surviving spouse is subject to income tax only to the extent distributions from the HSA are not used as qualified medical expenses. If the HSA passes to a person other than the surviving spouse, the HSA ceases to be an HSA as of the date of the death of the account owner, and the person receiving the HSA is required to include the value of the HSA in gross income, but reduced by any payments from the HSA made for the deceased owner's qualified medical expenses if paid within one year after death.
F. Miscellaneous Rules
If an employer makes HSA contributions, the employer cannot discriminate in favor of certain employees and, therefore, must make available comparable contributions on behalf of all those employees who have comparable coverage under the high-deductible health plan. Contributions are considered comparable if they are either the same amount or same percentage of the deductible under the high-deductible health plan. An HSA can be offered as an option under a cafeteria plan so that an employee may elect to have amounts contributed as employer contributions to an HSA on a salary reduction basis. Employer contributions to an HSA must be reported on Form W-2. The IRS will release forms and instructions in the future as to how to report HSA contributions, deductions and distributions. HSA's are not subject to COBRA continuation coverage.