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Health savings accounts: a way to help pay for health care cost.

INTRODUCTION

Health insurance is the largest line item in our budget, with the exception of payroll. It is more than rent, computer equipment, utilities, errors and omissions insurance, liability insurance, or supplies. And, bear in mind, health care benefits are in addition to the costs of retirement contributions, sick leave, vacation, and other benefits. Our annual benefits package exceeds $10,000 for each employee. With twenty-five full-time employees, a quarter of a million dollars is committed to benefits before one cent is paid in salaries and overhead. For a small professional services firm, this is a breath taking amount. This report provides an overview of the costs and benefits of Health Savings Accounts.

THE CASE FOR HEALTH SAVINGS ACCOUNTS

Employees want health benefits and employers recognize that a benefits package, including health insurance, is key to hiring and retaining competent people. However, health care benefits have become increasingly expensive. Over the past five years, health insurance premiums for our employees increased on average more than twenty percent each year. 2008 was a better year than most: the projected increase is only eight percent. Therefore, the opportunity to reduce costs with the advent of Health Savings Accounts is well worth our consideration. The primary cost savings arise from substituting a traditional Low Deductible Health Plan for a High Deductible Plan, which is supplemented with a Health Savings Account.

High Deductible Health Plans, however, have not been an option favored by employees. That may change with the availability of Health Savings Accounts and an understanding of its advantages. A Health Savings Account allows employees to set aside tax-deductible funds to pay for the insurance deductible as well as health care costs not typically covered by health insurance. Moreover, Health Savings Accounts provide incentives that encourage employees to conserve heath care resources. If patients pay some of their health benefits, they may monitor their own habits--eating more wisely, exercising, not smoking, drinking alcohol in moderation--and use health care resources more efficiently and effectively. Nevertheless, a concern remains. In the first years of a High Deductible Plan, the amount deposited in a Health Savings Account may be insufficient to cover the deductible.

THE ACT

The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the Act), [section] Section 1201, created Health Savings Accounts. Of course, there are conditions that must be met to participate. The Health Savings Accounts must accompany a High Deductible Health Plan. The deductible must be at least $1,100 for individuals or $2,200 for families and the annual out-of-pocket expenses cannot exceed $5,600 for an individual or $11,200 for a family. These amounts include the deductible and co-payments, but not premiums.

Contributions to Health Savings Accounts are tax deductible, grow tax-free, and are immediately vested. Amounts not used for medical bills stay in the account and grow tax-free to cover future medical bills or, when the time comes, to supplement retirement benefits. Even after the owner of a Health Savings Account is no longer covered by a High Deductible Health Plan, money in the account continues to be tax-free as long as it is used for medical expenses.

Although a major concern is the risk of self-insurance, high deductibles have a potential cost with established contractual limits. Major health problems and the accompanying losses are still covered by the High Deductible Health Plan. Therefore, given the benefits, employees and employers may be willing to accept the risk compared to alternatives, including employers either paying less of the premium for health insurance coverage or dropping coverage altogether.

HOW HEALTH SAVINGS ACCOUNTS WORK

Anyone under 65 who purchases a High Deductible Health Plan can open a Health Savings Account. Individuals can buy a High Deductible Health Plan or have such plans through their employers. Likewise, contributions to a Health Savings Account may be paid by employees and/or employers. Employers' as well as employees' contributions to Health Savings Accounts are deductible from income. Unlike other tax breaks, there are no personal income limits on who is eligible. Contributions to a Health Savings Account are tax-deductible only if deposited on or before April 15. However, contributions need not be made in a lump sum or even on a regular basis. Furthermore, unused Health Savings Account balances can roll over from year to year and continue to grow tax-free.

As with other tax sheltered payments, restrictions affect participation in Health Savings Accounts. For example, according to Revenue Ruling 2004-38, combining a prescription drug card with a High Deductible Health Plan will disqualify the policyholder from participating in a Health Savings Account. Note that the limitations tend to be in the nature of what is covered by the High Deductible Health Plan rather than collateral or additional insurance. For example, workers' compensation, tort, property, or similar insurance identified by Federal regulation, does not prevent participation in a Health Savings Account. So, insurance for a "specified disease or illness" ("a cancer policy") or insurance paying salary replacement for a fixed period of time does not make a person ineligible for a Health Savings Account.

CONTRIBUTION REQUIREMENTS

Restrictions are applicable to contributions, too. Each year individuals or their employers may contribute an amount of the deductible up to $2,900 for singles and $5,800 for families. Someone who is at least 55 years old can invest an additional $900 in 2008 and an additional $1,000 in 2009. Employees can decide how much to contribute to their accounts and can replenish used amounts throughout the year.

An important cautionary note to employers is that if they make the contributions, they must be "comparable." "Comparable" contributions require paying either the "same dollar amount or the same percentage of each employee's deductible" (www.treas.gov/offices/publicaffairs/ hsa/faq_employer-participation.shtml#hsa5). Contributions cannot be computed on the basis of an employee's income. If contributions are not "comparable," the employer is subject to penalties.

DISTRIBUTION REQUIREMENTS

The money deposited in a Health Savings Account can be withdrawn by check or debit card to pay medical bills. Participants appreciate the fact that funds from a Health Saving Account can be used to pay costs like dental and vision which are not covered by typical heath insurance policies. Funds from Health Savings Accounts can also be used for preventive care. While the statute does not define "preventive care", IRS Notice 2004-23 provides some "safe harbor" "preventive care items" including "periodic health evaluations, routine pre-natal and well-child care, tobacco cessation programs, obesity weight-loss programs, and a wide array of screening services", such as "cancer, diabetes, mental health, and metabolic and nutritional conditions."

Because funds paid into a Health Savings Account are immediately vested, an employee can continue to use the resources if s/he changes employment or is no longer covered by a High Deductible Health Plan. If not used, the funds grow tax-free until death or when the employee is eligible for Medicare. At that time the funds can be withdrawn without penalty.

If funds are inadvertently used for something not permitted by regulations, no tax penalty is incurred as long as the amount is repaid to the Health Savings Account. However, if a mistaken distribution is not repaid or if funds are intentionally used for something other than qualified medical expenses, the funds are taxed as ordinary income and subject to a 10% penalty. No penalties are incurred regardless of how the money is used if it is distributed after the death or disability (within the meaning of Code Section 72(m)(7)) of the Health Savings Account owner, or after they reach the statutory age for Medicare eligibility.

HOW TO IMPLEMENT A HEALTH SAVINGS ACCOUNT

Once a High Deductible Health Plan is in place, a Health Savings Account can be established at any financial institution--a bank, for example. There are a variety of investment vehicles for Health Savings Accounts including saving accounts, mutual funds, and stocks and bonds. As a general rule, except for a common trust managed by a financial institution, funds contributed to a Health Savings Account should be maintained in a separate account. Bear in mind that in setting up an account and maintaining records, individuals, not their employers or the Health Savings Account custodian, are responsible for maintaining records to show that Health Savings Account funds are used only as permitted by law and regulation.

CONCLUSION

For self-employed and small to medium sized businesses, traditional low deductible health insurance premiums have become prohibitively expensive. A High Deductible Health Plan combined with a Health Savings Account may provide a cost-effective alternative. Health Savings Accounts offer 1) lower health insurance premiums, 2) lower taxes, 3) an incentive to conserve health care resources, and (4) the potential of more cash at retirement.

If employees participate in and share the costs of a High Deductible Health Plan/Health Savings Account, they should more fully appreciate the costs of insurance, the benefits of preventive health care, and its effect on business' productivity--or so employers and lawmakers hope. This in turn should help contribute to fewer health-related losses, reduced expenses to the business for down time or employment of temporary help. A further consequence, therefore, may be higher profitability--or so employers hope. The success of High Deductible Health Plans/Health Savings Accounts is yet to be seen, but they have potential that is worthy of consideration.

As with any new tax incentive, compliance has numerous exceptions and limitations. Failure to comply with the statute and IRS guidance may result in contributions becoming taxable, along with penalties. This report provides an overview of High Deductible Health Plans and Health Savings Accounts. Health Savings Account Notice 2004--50 (http://www.benico.com/Laws/HSA_notice_2004-50.pdf) may help establish tax compliant Health Savings Accounts. For more details about Health Savings Accounts also see, www.treas.gov/offices/public-affairs/hsa/pdf/HSA-Tri-fold-english-07.pdf

REFERENCES

72t on the Net. Code Section 72(m)(7)). Retrieved October 31, 2008, from http://www.72t.net/Sepp/ IrcSection72.aspx

Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the Act), [section] Section 1201. Retrieved October 31, 2008, from http://www.ustreas.gov/offices/public-affairs/ hsa/pdf/pl108-173.pdf

United States Department of The Treasury. Health Savings Account Notice 2004-50. Retrieved October 31, 2008, from http://www.ustreas.gov/press/releases/reports/hsanotice200450072304.pdf

United States Department of The Treasury. IRS Notice 2004-23. Retrieved October 31, 2008, from http://www.ustreas.gov/press/releases/reports/notice200423.pdf

United States Department of The Treasury. Retrieved October 31, 2008, from http://www.ustreas.gov/offices/publicaffairs/hsa/pdf/ fact-sheet-dramatic-growth.pdf

United States Department of The Treasury. Retrieved October 31, 2008, from http://www.treas.gov/offices/publicaffairs/ hsa/faq_employer-participation.shtml#hsa5

United States Department of The Treasury. Retrieved October 31, 2008, from http://www.treas.gov/offices/publicaffairs/ hsa/pdf/HSA-Tri-fold-english-07.pdf

Chauncey M. DePree, Jr., University of Southern Mississippi

Rebecca K. Jude, JD, Jude & Jude, PLLC
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Author:DePree, Chauncey M., Jr.; Jude, Rebecca K.
Publication:Entrepreneurial Executive
Geographic Code:1USA
Date:Jan 1, 2008
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