Health Savings Accounts

Health Savings Accounts (HSAs) were created by the Medicare Prescription Drug, Improvement and Modernization Act, which passed in December 2003. With the increasing costs of traditional health insurance policies, HSAs may be another option to consider.

HSAs help you take control of your health care expenses with a tax-favored savings account and comprehensive medical coverage. An HSA is a tax-exempt trust established to pay for medical expenses of the account beneficiary who is covered under a high-deductible health plan (at least $1,000 for single coverage and $2,000 for family coverage). Money in the savings account is used to pay for medical expenses before the deductible is met and is not subject to tax. Once the deductible is met, the insurance starts paying. Money left in the savings account earns interest or dividends and is available for use in future years.

Virtually everyone is eligible to have an HSA regardless of income except those who are covered by any low-deductible plan, individuals claimed as a dependent on another person's tax return, and individuals who become entitled to Medicare benefits.

If an HSA is established by an individual without employer involvement, the individual receives a tax deduction for the amounts contributed to the HSA. If an employer contributes toward the HSA of an employee, the employer gets a deduction for the amounts contributed to the HSA. The amounts contributed are excluded from the employee's income.

Contributions can be made at one time or in any number of installments, but no later than the due date for the employee's federal income tax return.

Amounts contributed are limited to the lesser of the plan deductible or $2,600 for individual coverage and $5,150 for family coverage. These amounts will be indexed for inflation in the future. There are "catch up" contributions of $500 for individuals who have attained age 55 by the end of the taxable year. Amounts in the HSA will grow on a tax-free basis.

Upon death or divorce, an HSA can be transferred to a spouse without it being a taxable event, provided the funds are retained in the HSA.

Unlike health flexible spending accounts that have a "use it or lose it" provision, any amounts remaining in an HSA may continue to stay in the account and be carried over for future years.

The IRS issued the first guidance on HSAs with Notice 2004-2. Additional guidance is expected by June 2004. While they are very new and some questions still remain, health savings accounts may be another option for taxpayers to consider.