Typically one of the most important benefits businesses have provided to their employees is a health plan covering their medical expenses. The typical health plan covers expenses by means of insurance with prescribed copays and deductibles determining the premiums the employer must pay. It is difficult for employees to gain a full appreciation for the true cost of each of the healthcare costs they are incurring and the cumulative effect on the next year’s premium.

As an alternative to the low deductible health insurance plan, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 included provisions permitting individuals and businesses to establish a new type of health plan called a Health Savings Account (HSA). An HSA is a form of consumer-driven health plan which rewards individuals for limiting medical expenses by permitting unused amounts, the savings portion of the account, to be carried over to a later year. The idea is that this type of plan will motivate consumers to become more prudent healthcare purchasers if they have a financial stake in the outcome.

Health Savings Accounts are similar to an Individual Retirement Account (IRA) but are used to pay medical costs. An HSA is a tax-exempt trust or custodial account maintained by a health plan provider. The HSA is funded with pre-tax dollars contributed by the individual/employees, the employer or both. Contributions by individuals are deductible even if they do not itemize deductions on their income tax returns. Contributions by the employer are deductible on their tax returns, excludible from income by their employees, and are not subject to federal payroll taxes. The HSA portion of the plan is a pre-tax savings account, which to the extent it is not used to pay medical costs can accumulate earnings tax-free and can carry over to future years. Distributions from the account to pay medical costs are not taxable.

To qualify for an HSA, the employee/individual must be covered by a High Deductible Health Plan (HDHP) and cannot be covered by another non-HDHP. An HDHP is a health insurance funded plan, which for 2005 has, for self-only coverage an annual deductible of at least $1,000 and an annual out-of-pocket limit for expenses of $5,150. For family coverage, the 2005 minimum deductible is $2,000 and the out-of-pocket limit is $10,200. The HSA coupled with the HDHP, with no other allowable health coverage, is essential to the concept of a consumer-driven health plan. These rules are designed to ensure that the individual is responsible for the first level of medical expenses, which are paid out of the HSA portion or out-of-pocket. This provides an incentive to spend healthcare dollars wisely.

The law imposes a maximum amount that may be contributed to an HSA on an annual basis. The maximum contribution is the lesser of: (1) the deductible under the HDHP, or (2) $2,650 for self-only coverage or $5,250 for family coverage. These limits will be adjusted for cost-of-living increases in the future.

Employers can allow employees to contribute to their HSA through a cafeteria plan and premiums for the HDHP can also be paid through a cafeteria plan. Employers switching from a low deductible health plan to an HDHP will typically want to contribute to the employees’ HSAs the reduction in premium from increasing the deductible.

To the extent the HSA can accumulate funds after paying medical expenses, the HSA can invest the funds just like an IRA. At age 65, the HSA can distribute the funds to the employee/individual for retirement. The distributions would be taxable at that time but would not be subject to penalties.

The HSA consumer-driven health plan is a new concept which is still in the evolution phase. Hopefully, it will help control increasing health costs and provide additional benefits to individuals and employees for the future.

		Robert E. Miller, CPA is a principal at Maner, Costerisan & Ellis, PC. He specializes in serving business needs from a tax perspective, including compliance and planning.