Client Information Bulletin
Have You Considered an HSA?

President Bush signed the Medicare Prescription Drug Modernization Act of 2003 and created the health savings accounts (HSAs). The idea is fairly simple: to provide health care consumers with an alternative to high health insurance costs, and give tax breaks as an incentive to save money to pay out-of-pocket health expenses.

Millions of Americans have signed up for HSA-eligible insurance policies, but only a fraction of those individuals have actually opened an HSA. Lack of awareness may be one reason. Lack of understanding is almost certainly another. If you fall into either of those groups, this simplified explanation of how an HSA works may help.

A health savings account looks and acts a lot like an Individual Retirement Account (IRA), the retirement savings option that has been building wealth and reducing income taxes for more than two decades. There are important differences, but the similarities include —

  1. Tax-deductible contributions (with limits),
  2. Tax-free withdrawals (for eligible expenses),
  3. Tax-free earnings,
  4. Flexible investment options, and
  5. Available whether or not deductions are itemized

For an individual to establish an HSA, he/she must first be covered by a qualified high deductible health insurance policy, with out-of-pocket minimums of $1,050 for a single person, and $2,100 for family coverage. It doesn't matter if this coverage is offered by an employer or is purchased by an individual.

Secondly, the individual needs to establish a savings account contributed to by the individual and/or the employer. The idea is for the money saved by lower insurance premiums to be invested in the HSA for future out-of-pocket expenses.

When qualified medical expenses are incurred, funds can be withdrawn from an HSA to cover those costs. There are limits on how much money can be contributed to the account. In 2006, contributions up to $2,700 for individuals and $5,450 for families are tax deductible. There are no limits or phase-outs based on income.

In order for a withdrawal to be tax-free, it must be used to pay medical expenses for the account holder, spouse or dependents. Tax-free withdrawals can not be made to pay health insurance premiums. Tax will be due, plus a 10 percent penalty, if withdrawals are made for any reason other than qualified health care expenses.

The rules change somewhat when the account beneficiary reaches the Medicare-eligible age of 65. At that point, withdrawals can be made for any reason. Federal income tax will be owed on the withdrawals, but the 10 percent penalty will not apply. The penalty is also waived if the account beneficiary becomes disabled or dies.

What constitutes a qualified expense also changes at age 65. Tax-free withdrawals can be made to pay health insurance premiums, including Medicare Part A and Part B premiums, Medicare HMO premiums, and the employee's share of premiums for an employer-sponsored plan.

Is an HSA right for you? Because an HSA brings in elements of health insurance, retirement savings and tax planning, choosing a health savings account may not be a task for the "do-it-yourselfer." Everyone can use another tax deduction, but before making a commitment to a health savings account, contact the professionals at Holmes & Associates Chartered for information, strategies and insights.