Federal legislation enacted in late 2003 authorized the creation of Health Savings Accounts (HSAs). These savings accounts are combined with a high-deductible health plan. Because high-deductible plans generally cost less than low-deductible plans, HSAs are a good option for employers who cannot afford a comprehensive (low-deductible) health plan.
Both employers and employees may contribute to HSAs. Total annual contributions to the savings account may be up to 100% of the annual health plan deductible amount and may be used to pay for any qualified medical expenses. The savings account is controlled by the covered employee and is intended to pay small and routine health care expenses.
Once the deductible amount is reached, additional health expenses are covered in accordance with the provisions of the health insurance policy. For example, an employee might then be responsible for 10% of the costs for care received from a PPO network provider.
Deposits made to an HSA are tax-free to the employer and employee, and money not spent at the end of the year may be rolled over to pay for future medical expenses. Money from the HSA may be withdrawn for any reason, but if it’s not for qualified medical expenses as defined under §213(d) of the Internal Revenue Code, the withdrawal is subject to a 20% penalty and is included in gross income for income tax purposes. (The penalty is waived in a few cases: if the beneficiary dies, becomes disabled or reaches age 65.)
The contribution limits, out-of-pocket expenses and deductible amounts are indexed to inflation. In 2013, the limits for individuals are as follows, according to the IRS:
- A deductible of $1,250 or more.
- Total annual out-of-pocket expenses (other than premiums) for covered benefits not to exceed $6,250.
- Annual contributions not to exceed the lesser of 100% of the deductible or $3,250.
The limits in 2011 for families are:
- A deductible of $2,500 or more.
- Total annual out-of-pocket expenses (other than premiums) for covered benefits not to exceed $12,500.
- Annual contributions not to exceed the lesser of 100% of the deductible or $6,450.
Note: Individuals and couples 55 or older may contribute more to the account per year.
Example: For married workers, an employer might provide a family policy that has a $5,000 deductible while depositing 60% of the deductible ($3,000) in each employee’s HSA at the beginning of the year. (Employer contributions must be the same for all employees.) Workers would be responsible for the first $5,000 in medical costs, but they would each have $3,000 in their personal HSA to pay for medical expenses (and would have even more if they, too, contributed to the HSA). If workers or their families exhaust their $3,000 HSA allotment, they would pay the next $2,000 out of pocket, whereupon the insurance policy would begin to pay.
Under the Patient Protection and Affordable Care Act, there has been a small increase in the additional tax that applies to early distribution for nonqualified medical expenses before age 65. For HSAs, the tax has increased from 10% to 20%.
The Archer Medical Savings Account (MSA) was a federally qualified program that allowed the self-employed or individuals who work for an employer with 50 or fewer employees to establish savings accounts in conjunction with high-deductible health insurance policies. The Archer MSA program was discontinued as of December 31, 2003—that is, Archer MSAs may no longer be established. However, rollovers from Archer MSAs to HSAs are permitted, and individuals who already have Archer MSAs may keep them.
Under the Affordable Care Act, the tax that applies to early distribution for nonqualified medical expenses before age 65 will increase from 15% to 20% for Archer MSAs.