August 21, 2009
BACKGROUNDER: HEALTH SAVINGS ACCOUNTS AND HIGH DEDUCTIBLE HEALTH PLANS
By: Janet L. Kaminski Leduc, Senior Legislative Attorney
HEALTH SAVINGS ACCOUNTS
Effective January 1, 2004, federal tax law established health savings accounts (HSAs) through which people may accumulate funds on a pre-tax basis. The HSA funds must be used to pay for qualified medical expenses. HSAs are generally offered by employers and funded directly through payroll deductions. But HSAs do not have to be employer sponsored. An HSA is set up through a trustee, which can be a bank, an insurance company, or anyone approved by the IRS to be a trustee of individual retirement arrangements (IRAs) or medical savings accounts (MSAs). In order to open an HSA, a person must, among other eligibility criteria, be enrolled in a high deductible health plan (HDHP).
A person is eligible to open an HSA if he or she is:
● covered by an HDHP as defined by federal law;
● not covered by any other type of medical plan, except as federal law permits (see below);
● not enrolled in Medicare; and
● not claimed as a dependent on someone's tax return.
A person enrolled in Medicare can continue to use any accumulated HSA funds to pay qualified medical expenses, but he or she is no longer eligible to make contributions to the account (or have contributions made on his or her behalf).
The HSA account belongs solely to the employee. There is no such thing as a joint HSA. Each person who wants an HSA must open his or her own. But an employee may use his or her HSA funds to pay for qualified medical expenses incurred by dependents (i.e., those who satisfy the definition of dependent for federal tax purposes).
The HSA owner cannot have any other health coverage that is not an HDHP. However, federal law permits the account owner to be covered by the following types of coverage (whether provided through insurance or otherwise): accident, disability, dental, vision, long-term care, workers' compensation, liability (tort and property), specific disease or illness, and per diem hospital coverage.
Dependents whose medical expenses are paid from the owner's HSA may be covered by other plans, as long as the owner is not covered by such plan.
HSA contributions may be made by the account owner, his or her employer, any other person or entity on the owner behalf, or any combination thereof. An employer does not have to make contributions, but if it chooses to it cannot attempt to recoup the funds later (i.e., the contributions are non-forfeitable). An employer that chooses to make contributions may do so in a lump sum annually or on a monthly, quarterly, or other basis. Employer contributions must be “comparable,” meaning they must be in the same dollar amount or percentage of the employee's deductible for all employees with the same category of coverage. Employees covered by a collective bargaining agreement are not covered by the comparability rules if health benefits were part of the agreement.
HDHP plans offered through a Section 125 (salary reduction or cafeteria) plan have different rules. Instead of the comparability rules, an employer sponsoring a Section 125 plan has to comply with “non-discrimination” rules, under which it cannot favor highly paid employees, as defined in federal law, relative to eligibility, contributions, and benefits. But the law allows an employer to make larger contributions for lower paid employees (thus, it can discriminate in favor of non-highly paid employees). Given the non-discrimination rules, an employer with a Section 125 plan generally can only distinguish between full- and part-time employees and individual and family coverage.
Employers may prorate contributions to employees' HSAs. For example, if an employer decides to contribute $500 annually to each HSA, an employee hired effective July 1 could be given $250 for the remaining six months of the year.
Subject to certain limitations, contributions to an HSA are not subject to federal income or employment taxes. Connecticut taxes are based on federal adjusted gross income; thus, in Connecticut HSA contributions also are not subject to state income taxes. Amounts in an HSA that are not used by year end are carried over to future years without limit.
Federal law sets limits on the amounts that may be contributed on a tax-preferred basis to an HSA. The Treasury Department adjusts the limits annually for cost of living increases. New limits are generally announced in June and effective the following January. The limit depends on the type of HDHP coverage the person is covered by (i.e., self only or family). Current applicable limits are:
Table 1: Health Savings Account – Maximum Contribution
A person who is or will be at least age 55 in a given year may make additional “catch up” contributions of up to $1,000 annually, until enrolled in Medicare.
If a person (or an employer or other entity) makes contributions to an HSA that exceed the annual limits, federal law consider these to be “excess contributions.” A person can withdraw excess contributions before the end of the year to avoid an excise tax on them. If excess contributions are not withdrawn, they are subject to a 6% excise tax.
A person who opens an HSA mid-year can still contribute the full-year amount to the account, as long as he or she would have been eligible for an HSA during the prior 12 months (e.g., was not covered under any other non-HDHP).
The HSA account owner may name an account beneficiary in the case of death. Deductions from the HSA are allowed for one year after the owner's death to pay for his or her qualified medical expenses incurred before death.
If the owner's surviving spouse is the beneficiary, the spouse will be considered the HSA's account owner and be able to use the account funds, but the spouse will not be allowed to make contributions. If any other person is the beneficiary, then the account ceases to be an HSA on the owner's death and the fair marker value of any remaining assets is includable in the deceased's estate.
Qualified Medical Expenses
An HSA must be used to pay for qualified medical expenses as defined in federal law (I.R.C. § 213(d)) incurred by the account owner (e.g., employee), his or her spouse, and anyone qualifying as the employee's dependent for federal tax purposes. (Note: Connecticut law and federal law differ as to the definition of spouse and the definition of dependent for health care purposes. Thus, since HSAs follow federal law, an HSA may not be used to pay for expenses incurred by a same-sex spouse or an adult child, even though state law allows them to be covered under the corresponding HDHP.)
If a person uses the funds for non-qualified expenses, the funds are subject to federal and state income taxes and, if a person is under age 65, a 10% penalty.
The funds may also be used to pay for the following types of premiums:
● COBRA continuation coverage;
● qualified long-term care insurance;
● health coverage during any period the person is receiving unemployment compensation; and
● Medicare or retiree health insurance, excluding Medicare Supplement plans, for people age 65 or over.
Qualified medical expenses, as defined in law, include amounts paid for the diagnosis, treatment, or prevention of disease and for treatments affecting any part or function of the body. The expenses must be for alleviating or preventing a physical defect or illness. Expenses for solely cosmetic reasons generally are not expenses for medical care (e.g., face lifts, hair transplants, and hair removal). Also, expenses that are merely beneficial to one's general health (e.g., vacations) are not qualified medical expenses.
HIGH DEDUCTIBLE HEALTH PLAN
To be a qualified HDHP for HSA purposes, a plan must meet specified criteria. An employer can offer a non-qualified HDHP, but then employees will not be eligible to open HSAs.
Federal law sets a minimum plan deductible and a maximum out-of-pocket (OOP) limit for self only and family coverage under a qualified HDHP. OOP expenses do not include premiums. The amounts are adjusted annually for cost of living increases. An employer sponsoring an HDHP may establish a higher plan deductible and a lower OOP limit. A network plan (i.e., one that offers in-network versus out-of-network coverage) must comply with the OOP limit maximum on the in-network benefits. The out-of-network benefits may have a higher limit (thus, a person is encouraged to use in-network care).
Table 2: High Deductible Health Plans – Minimum Deductible
and Out-of-Pocket Maximum
Maximum OOP Limit
There are no specific requirements as to what benefits an HDHP must cover (but see Mandates below). But all covered services and expenses must be subject to the plan deductible and OOP limit. There cannot be separate internal benefit deductibles or limits. Benefits are generally subject to a coinsurance requirement. A person must pay the deductible and the coinsurance amount. After the plan deductible is
satisfied, the person continues to pay the coinsurance until he or she meets the OOP limit. After reaching the OOP limit, the plan pays 100% of covered expenses incurred.
If prescriptions are included as a covered expense, they are paid the same as other expenses (subject to the plan deductible, coinsurance, and OOP limit) and cannot have a separate copay or deductible. The plan can still have a formulary and negotiate discounted prices with a pharmacy benefit manager.
An HDHP may pay for preventive care, as defined in Treasury guidance, at 100% without deductible or with a deductible that is below the minimum plan deductible. Preventive care at 100% is a fairly common plan design, though, as a way to encourage preventive medicine.
If a plan carves out mental health benefits, prescriptions, or both to a separate plan, the separate plan must also qualify independently as an HDHP.
Preventive care includes, among other things:
● periodic health evaluations, including tests and diagnostic procedures ordered in connection with routine examinations, such as annual physicals;
● routine prenatal and well-child care;
● child and adult immunizations;
● tobacco cessation programs;
● obesity weight-loss programs; and
● screening services, including those for:
○ heart and vascular disease;
○ infectious disease;
○ mental health conditions;
○ substance abuse;
○ metabolic, nutritional, and endocrine conditions;
○ musculoskeletal disorders;
○ obstetric and gynecological conditions;
○ pediatric conditions; and
○ vision and hearing disorders.
Funding Arrangement and Mandates
HDHPs may be self-insured or fully-insured. Applicability of state insurance benefit mandates depend on the plan's funding arrangement. If fully-insured, the plan must comply with state, as well as federal, mandates. If self-insured, state mandates generally do not apply (due to federal exemption under ERISA), but the plan still must comply with federal benefit requirements.
If a state law makes a fully-insured HDHP noncompliant with federal requirements, it is no longer qualified for HSA purposes. (This is why, for example, new insurance mandates limiting the amount that can be charged for a deductible exclude plans intended to be qualified as HDHPs under federal law.) If state laws prevent HDHPs from complying with federal requirements, HSAs could not be sold in Connecticut.