A Health Savings Account may be the answer to insurance cost dilemmas

Industrial Distribution - July 1, 2004

Bart A. Basi and Roman A. Basi

No, your eyes are not playing tricks on you, the title of this story does indeed say "decreasing." The Medicare bill that was signed into law on December 8, 2003 established a new and innovative insurance program for employers and employees called an "HSA", otherwise known as a Health Savings Account. This revolutionary vehicle will help many employers, large and small, save taxes and save money on health insurance premiums.

What is an HSA?

An HSA is a tax-exempt account that is created for the purpose of paying qualified medical expenses. The HSA can be funded by the employer and/or the employee. To be eligible to create an HSA, you must be an individual who has a high-deductible health plan (HDHP). An HDHP is one in which a single individual has a yearly deductible of no less than $1,000, or if you have family coverage, the deductible can be no less than $2,000. In addition, if you have individual coverage, the out of pocket expenses required to be paid cannot exceed $5,000, and for family coverage, this amount cannot exceed $10,000.

Further requirements are as follows:

• You must not be covered under an insurance plan that is not an HDHP.
• You must not be entitled to Medicare benefits.
• You cannot be claimed as a dependent on another person's return.

If you meet all of the above requirements, you are an "eligible individual" for a Health Savings Account.

The Benefits of an HSA

Employee Benefits
An HSA has many benefits for employees. The first benefit is that 100 percent of the annual deductible for the individual or family can be contributed to an HSA. However, this amount can not exceed $2,600 for an individual, and $5,150 for family coverage. People ages 55 to 64 can make additional contributions to "catch up" in 2004 of $500. This will gradually increase to $1,000 in 2009.

The contribution to the HSA is tax-free to the employee. The employee can take a deduction for any amount he contributes to the HSA. This deduction is an "Above-the-Line" deduction, and therefore directly reduces an employee's taxable income.

An HSA is held in an account for the benefit of the individual, his spouse or children. This account is invested, and any gain on the investment is also tax-free. In addition, if an employee changes jobs, the account goes with him, as the employee is allowed to transfer the entire fund balance to his new job.

Finally, it should not be forgotten that if the deductible increases to $1,000 per person or $2,000 per family, the cost of the health insurance premiums will be less, resulting in cash savings.

Employer Benefits
There are also benefits to the employer. An employer is not taxed on the amounts he contributes to the account, and these amounts are also not subject to withholding for income tax, FICA, or FUTA. Therefore, an employer obtains a direct write off for the amounts paid not only for the health insurance premiums, but for the HSA as well.

In addition, most employers will see a reduction in the monthly premiums they pay for their employees due to the increase in deductibles (if the employer does not already have an HDHP).

The reduction in the premiums, and the tax deduction, will help to offset the cost of the employer funding a portion of the HSA, if they so wish to assist their employees with funding the HSA.

The disadvantages of an HSA

Disadvantages for Employees
The disadvantages of an HSA are few and far between. First of all, once you reach the age of 65, you can no longer contribute to an HSA. If you do contribute, all amounts will be taxable to you in addition to a penalty of 6 percent. This also occurs if you are considered an "eligible individual" and exceed the allowable amounts that can be contributed if you are less than 65 years of age.

If you do not use the funds for "qualified medical expenses," the funds that are used are included in your gross income, and a penalty of 10 percent is imposed. The 10 percent penalty is eliminated in the case of a distribution after the account beneficiary's death, disability, or once you have attained the age of 65.

An HSA can be transferred to a spouse tax free, but when an HSA is transferred to a person other than your spouse, it ceases to exist as an HSA. It is then included in the person's taxable income. This amount, however, is reduced by any amount paid by the HSA for the decedent's qualified medical expenses paid up to one year after their death.

Change in 2003 health care coverage:

A problem in 2003 was the dramtic growth in the costs of health care. In Industrial Distribution's 58th Annual Survey of Distributor Operations, 85 percent of distributors reported that their health care costs had increased.

Disadvantages for an Employer
One disadvantage for an employer is that a "comparability" rule applies. An employer must make comparable contributions to each individual's HSA. They must be either the same amount or same percentage of the deductible of an HDHP for each employee. No discrimination is allowed as to employees.

A second disadvantage is that the employee is deemed the owner of the HSA, and therefore if they were to quit or be terminated from employment, all employer-funded amounts remain the property of the employee. The employee is free to transfer their HSA to another employer, including all payments made by their former employer and all interest accumulated on those payments.

The Practical Effect

The practical effect for both an employer and an employee is a reduction in the overall cost of qualified medical expenses. The following example identifies the savings that are created by setting up an HSA:

Facts: An employer pays the premium for a single individual with a deductible of $500. This premium equals $250 per month.

The employer then increases the deductible to $1,000 in order to set up a qualified HSA. The premium is now reduced to $200 per month.

Results: The employer sees an immediate savings of $50 per month, or $600 per year. The employer then contributes $500 during the year to the HSA and obtains a tax deduction. The employee contributes $500 during the year to the HSA and has this amount deducted from his gross payroll. The employer saved $600, contributed $500 to the HSA tax free (thereby realizing a net savings of $100 + all payroll taxes on the $600). The employee contributed $500 to the HSA before taxes.

The greatest benefit to the employee is that normally the $500 deductible would be paid with after-tax income. Now the $500 deductible can be paid with pre-tax income. In addition, the employee can contribute his $500 at anytime, and therefore, does not have to contribute the money if he does not incur any expenses. Funds can be contributed as needed during the year, subject to the maximum amount allowed.

Remember, the employee also reaps the investment income from the entire amount, and can take this account with him as his employment may change from year to year.

The employer can contribute throughout the year, as he pays the medical premiums for his employees. Thus, an employer can save on the cost of the premiums, spread the payment amount over the year and save payroll taxes on the money contributed. This is in addition to making the employee happy.

Who Can Administer an HSA?

An HSA must be administered by a qualified HSA trustee or custodian. This includes an insurance company, bank, or a person approved by the IRS (approval may be difficult to obtain). It is important to check the cost of administration or approval and add that cost into the example above to determine the net savings to the parties involved. The Trustee can be different than the company that provides the HDHP, but you should first check with your insurance carrier to determine if they carry HSAs, and the cost of such plans.

A refreshing option

Health Savings Accounts (HSA) are as good as they sound. Decreasing the cost of health insurance is a refreshing option in today's rising inflationary economy. Small and large employers alike can now benefit from a quality health program. It is not often that we have the ability to reduce our health insurance costs. Therefore, it is imperative to reassess your employer-sponsored health insurance plan, and determine if an HSA is appropriate for your company.