Savings Accounts: The New Benefits Plan?
D. Shawn Mauldin and Patricia H. Mounce
2006 - Escalating insurance premiums and medical costs over
the past decade have hit individuals and businesses hard.
To address this concern, Congress has created various tax-favored
provisions, the newest of which took effect in 2004. As
a part of the Medicare Prescription Drug Improvement and
Modernization Act of 2003, health savings accounts (HSA)
were created as an improvement to flexible spending plans
and health reimbursement plans. HSAs replaced the experimental
of medical savings accounts (MSA) established in 1996. HSAs
provide greater benefits than some other tax-favored provisions;
however, they also have drawbacks.
spending accounts (FSA) allow employees to set aside pretax
dollars for reimbursement of qualified medical expenses.
FSAs carry numerous restrictions, particularly the “use
it or lose it” clause when part of a cafeteria plan.
As a result, many employees contribute only minimal amounts
to an FSA, to avoid forfeiting unused funds.
reimbursement accounts (HRA) are similar to FSAs, but are
generally paid by employers. Unused amounts cannot be carried
forward to future years, and HRAs are subject to Health
Insurance Portability and Accountability Act (HIPAA) rules
limiting tax-free reimbursements to expenses that would
otherwise be deductible. MSAs were a short-lived attempt
to overcome some of the restrictions encountered by FSAs
and HRAs. Many have suggested that MSAs were not attractive
because of limitations such as penalties for early withdrawal,
tight contribution limitations, and ceilings on the number
account. Unlike employer-held amounts in FSAs,
HRAs, and MSAs, the new HSAs must be set up as a tax-exempt
trust or custodial account. The IRS released model documents
that trustees may use as trust or custodial agreements (Health
Savings Trust Account, Form 5305-B, and Health Savings Custodial
5305-C). The trust is set up solely to pay qualified medical
expenses. HSAs differ from previous plans in that an HSA
trust can be set up without employer sponsorship. The trust
accounts are similar to IRAs and can be set up at banks,
credit unions, insurance companies, brokerages, or other
financial institutions (Damian Paletta, “Bankers Want
More Details on Health Savings Accounts,” American
Banker, May 2004). Because an HSA is held by a trustee
rather than by an employer, an employee will not lose any
amounts in the account because of a job change.
requirements. Four primary eligibility requirements
must be met for an individual to set up an HSA. First, an
individual must be covered under a high-deductible health
plan (HDHP), with either individual or family coverage.
when an individual is also covered by a health plan that
does not qualify as an HDHP, he is no longer eligible to
participate in an HSA. The IRS had provided some flexibility
in coverage that does not hinder an individual’s eligibility,
such as insurance related to liabilities incurred under
worker’s compensation law, insurance related to tort
liabilities, insurance to cover liabilities relating to
ownership or use of property, insurance for a specified
disease or illness, and insurance to provide a fixed payment
for hospitalization. Coverage for accidents, disability,
dental, vision, or long-term care is also permitted.
are several exceptions to the second requirement because
of problems encountered when workers want to set up an HSA
while covered under an FSA or HRA. An employee already covered
by an FSA or HRA that pays or reimburses qualified medical
expenses generally is not eligible to establish an HSA,
but there are some exceptions.
first exception allows a participant to suspend the HRA
before the beginning of an HRA coverage period. The plan
must not pay or reimburse, at any time, the medical expenses
incurred during the suspension period (except for the permitted
coverages listed above).
second exception allows for post-deductible FSAs or HRAs,
which cannot pay or reimburse any medical expenses incurred
before a minimum annual deductible amount is met (this deductible
does not have to be the same as the HDHP deductible).
third exception allows retirees’ HRAs to pay for medical
expenses. These arrangements may pay or reimburse only those
medical expenses incurred after retirement; in addition,
participants can no longer contribute to their accounts.
an individual must be younger than 65 in order to establish
an HSA. This age requirement coincides with the Medicare
individuals who can be claimed as dependents by another
person are not eligible to deduct a contribution to their
HSA. Even if an individual is not actually claimed as a
dependent by another, this rule holds true.
An HSA may receive contributions on behalf
of an eligible individual from the individual or any other
person, including an employer or family member. One major
advantage of HSAs is that contributions by individuals to
their accounts are tax deductible even if the taxpayer does
not itemize. Likewise, employer contributions are not included
in the employee’s income. The maximum contribution
for 2004 was $5,150 for family coverage and $2,600 for individual
over 55 can put an additional $600 into HSAs for 2005, and
that amount will increase in $100 increments annually until
it reaches $1,000 in 2009. All contributions, from an individual
and his employer, are reported on his Form 8889, which is
filed with Form 1040. Deductible contributions are not capped
at the employee’s earned income. One advantage for
companies that contribute to employee HSAs is that employer
contributions are not subject to employment taxes.
Compared to Other Plans
FSAs, earnings on HSAs are tax free, provided that the earnings
remain in the account or are used for qualified medical
expenses. An obvious improvement over previous plans is
that amounts not distributed for qualified medical expenses
by the end of the plan year can be carried over without
negative tax consequences.
MSAs were available only to self-employed individuals and
small businesses with an HDHP, HSAs are available to anyone
with an HDHP. An individual participant must have a deductible
of at least $1,000 ($2,000 for family coverage), but less
than $5,000 ($10,000 for family coverage).
HSAs were first introduced, taxpayers feared that other
health coverage would interfere with their eligibility because
of low-deductible items within an HDHP or coverage under
other insurance policies. The IRS has provided guidance
on items that do not hinder the eligibility of a participant.
Preventive healthcare costs for periodic health evaluations,
such as annual physicals, routine prenatal care, and well-child
care, are covered on a low-deductible basis by an HDHP plan
without jeopardizing the tax benefits of an HSA. In addition,
various screening services—including those for cancer,
heart, and vascular diseases; infectious diseases; obstetric
and gynecological conditions; mental health conditions and
substance abuse; and many others—may be covered without
hindering the plan. Smoking-cession and obesity weight-loss
programs may also be covered.
older accounts, withdrawals from HSAs used to pay for or
reimburse qualified medical expenses of the account owner,
spouse, and qualified dependents are tax-free. Qualified
medical expenses include expenses that would qualify for
the medical and dental deduction. Because the “use
it or lose it” rule does not apply to HSAs, withdrawals
can be made for postretirement qualified health expenses.
Withdrawals for purposes other than medical expenses are
subject to income tax, and, if distributed prior to age
65, death, or disability, withdrawals are also subject to
an additional 10% tax.
participants can roll over amounts from MSAs or other HSAs
within 60 days after the date of receipt. Participants can
make only one rollover contribution to an HSA during a one-year
period. Rollover contributions do not have to be made in
cash and are not subject to the annual contribution limits.
Participants may not, however, roll over into an HSA amounts
from an IRA, HRA, or FSA.
and Estate Planning Considerations
positive aspects of HSAs include retirement and estate planning
considerations. Once an individual reaches 65, distributions
may be made for any purpose without incurring the additional
10% tax. Once an individual reaches Medicare eligibility,
however, tax-free contributions are not allowed. When an
HSA holder dies, assuming the beneficiary is a spouse, the
account becomes the spouse’s HSA. If the beneficiary
is not a spouse, the account ceases to be an HSA and the
beneficiary will not be limited by HSA rules. The beneficiary
is, however, taxed on the fair-market value of the assets,
reduced by any qualified medical expenses paid by the beneficiary
for the decedent within one year of death. If the HSA holder’s
estate is the beneficiary, the account value is included
in the individual’s final tax return.
negative aspect for employers contributing to HSAs is the
provision for immediate vesting, and employee freedom to
withdraw funds for nonmedical purposes (J. Geisel, “Government
HSA Guidance Expected to Answer Key Questions, Boost Use,”
Business Insurance, June 2004). Although these
distributions are taxable to the employee and subject to
a 10% penalty, employees might be willing to pay the penalty
to receive the employer-provided funds.
drawback is the complex rules governing HSAs (Geisel, 2004).
For example, when both spouses are covered by HDHPs, or
when one spouse enters the HSA during the year, a complex
set of rules must be followed. Another complexity is that
Form 8889 must be filed if any activity occurred during
the year, even if the taxpayer’s employer made contributions
to the HSA.
downside to HSAs is that contributions must be made in cash.
Individuals or employers cannot contribute assets, such
as stock. As previously mentioned, an exception to this
rule is rollover contributions from MSAs or other HSAs.
HSA providers often charge high fees for opening or closing
accounts, as well as for each transaction. The high fees
may not translate into higher savings or more services (Kaja
Whitehouse, “Fees of Health Savings Accounts Draw
Scrutiny of Consumers,” The Wall Street Journal,
July 20, 2005).
and Cons of HSAs
have been highly debated in Washington. Opponents argue
that HSAs have the potential to undermine the healthcare
system, will do little more than add another tax shelter
for the wealthy, and will increase the number of uninsured
Americans if they encourage some employers to drop healthcare
coverage for workers (J.B. Finkelstein, “New Health
Savings Account Perk Pushed,” American Medical
News, June 2004). In addition, critics say they will
not help the uninsured working poor, who do not have discretionary
cash to contribute to HSAs.
of HSAs counter that, in the long run, the plans will reduce
an employer’s health costs and are “consumer-directed,”
designed to let a participant select the timing and level
of health expenditures (R.B. Barker and K.P. O’Brien,
“Health Savings Accounts: Many Issues, Fewer Solutions,”
Benefits Law Journal, Summer 2004). The growing
popularity of HSAs is evidenced by the increased number
of employers who are adding this option to their employee
benefit plans. A survey by the U.S. Chamber of Commerce
found that two-fifths of the 1,000 employers surveyed were
likely to offer an HSA in 2005, and almost three-quarters
indicated that they were likely to do so in 2006 (Finkelstein,
2004). The number of HSAs reached 391,000 in 2005, and some
experts expect the number to reach 6.3 million by 2008 (Lee
Conrad, “For the Enterprising, Health Savings Funds
Are Anything But Bitter Medicine,” USBanker,
healthcare costs and health insurance premiums affect most
Americans. Individuals and businesses look for remedies
to balance adequate medical coverage with affordable plans.
For CPAs advising businesses on how to minimize costs while
providing maximum employee benefits, HSAs represent a new
tool. HSAs may prove to be a useful way to supplement high-deductible
health insurance and give employees a tax-favored benefit.
Shawn Mauldin, PhD, CPA/PFS, CMA, CFP, is
the dean of the college of business administration at Nicholls
State University, Thibodaux, La.
Patricia H. Mounce, PhD, CPA, is an associate
professor of accounting at the University of Central Arkansas,