christopher s. sears ice miller llp one american square indianapolis, indiana 46282 (317) 236-5891...
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Christopher S. SearsIce Miller LLP
One American SquareIndianapolis, Indiana 46282
(317) 236-5891
Alphabet Soupin Employee Health Expense AccountsAlphabet Soupin Employee Health Expense Accounts The Evolution of Employee Health Expense
Accounts:o Flexible Spending Arrangement (“FSA”), 1979
o Health Reimbursement Account (“HRA”), 2002
o Health Savings Account (“HSA”), 2003
Alphabet Soup – FSA OverviewAlphabet Soup – FSA Overview FSA: Flexible Spending Arrangement
o Usually employee contributions through 125 plan (can be unfunded)
o Subject to use-it-or-lose-rule
o Limited to qualified medical expenses
o Employer must substantiate expenses before reimbursement
Alphabet Soup – HRA OverviewAlphabet Soup – HRA Overview HRA – Health Reimbursement Account
o Must only be employer contributions (can be unfunded)
o Accounts may roll over into next taxable year
o Limited to qualified medical expenses (but can include insurance premiums)
o Employer must substantiate expenses before reimbursement
Alphabet Soup – HSA OverviewAlphabet Soup – HSA Overview The “Medicare Prescription Drug Act” was
signed into law on December 8, 2003 This law added new Section 223 to the Internal
Revenue Code to create and govern Health Savings Accounts (“HSAs”)
Amended Internal Revenue Code Section 106 to allow for exclusion of amounts contributed to HSAs by an employer from employee income
What is an HSA?What is an HSA? An IRA-like account used to pay for qualified
medical expenses Has unique tax features—contributions are tax-
deductible going in, and tax free upon withdrawal if used for qualified medical expenses.
Must be coupled with a high deductible health plan (“HDHP”)
Must be established with a qualified HSA trustee (such as an insurance company, bank, or other person or entity approved by the IRS to be a trustee or custodian)
Why did Congressand the President Adopt HSAs?Why did Congressand the President Adopt HSAs? The government hopes that HSAs will:
o Increase personal control over health care dollars
o Increase private ownership of health insurance policies. (This will shift the currently dominant employer-offered insurance model so it will resemble how we purchase car insurance.)
o Decrease the number of uninsured Americans
It’s part of the “Ownership Society” concept, which states that people will be more careful about their health care dollars if they “own” the money and could profit from prudent decisions.
How Can HSAs Foster an “Ownership Society?”How Can HSAs Foster an “Ownership Society?” PERSONAL RESPONSIBILITY: HSA holders
will take time to become more savvy consumers. FREEDOM TO CHOOSE: Structure will allow
consumers to choose one’s own doctor and health insurance policy.
COMPETITION BETWEEN PROVIDERS: Individual ownership will make markets more competitive. Doctors and insurance companies must work harder to earn business.
Are HSAs a “Silver Bullet” that will Cure the Broken Health Care System? Are HSAs a “Silver Bullet” that will Cure the Broken Health Care System? No, the government sees HSAs as an alternative option, not a
replacement to other health care options such as conventional employer-sponsored insurance programs or Medicare/Medicaid.
Potential negative impacts during a transition to HSAs: o Employers could reap the cost savings from offering only
HDHPs, and not pass any of the savings on to employees. o This interim period could leave sick, lower-paid employees
vulnerable if they do not have the means to pay the high deductible
o The oldest and sickest consumers (those who are responsible for most health care costs) can not effectively shop for health care.
o Availability of consumer data to compare providers and services is currently very poor
Who is Eligible to Establish an HSA?Who is Eligible to Establish an HSA? Eligibility status is determined on a month-by-
month basis Any individual who as of the first day of the
month:o Is covered under a high-deductible health plan (HDHP)o Is not covered under any other health plan (whether as an
individual, spouse, or dependent) that is not an HDHP and that provides for any benefit covered by the HDHP
o Is not entitled (eligible and enrolled) to benefits under Medicare
o May not be claimed as a dependent Do not need to be an employee – can set up as an
individual
What is a High-deductible Health Plan?What is a High-deductible Health Plan? Deductible limits (indexed to increase with inflation)
o At least $1,050 for single coverage (for 2006)o At least $2,100 for family coverage (for 2006)
Deductible limits do not apply for preventative care (see IRS Notice 2004-23)o Periodic health evaluationso Routine prenatal and well-child careo Child & adult immunizationso Tobacco cessation programso Obesity weight-loss programso Screening services o Treatment that is ancillary to preventative careo Preventative care drugs (for someone with risk factors, but
asymptomatic)
What is a High-deductible Health Plan?What is a High-deductible Health Plan? Out-of-pocket expense limits (includes
deductibles & co-pays, but not premiums)o No more than $5,250 for single coverage (for 2006)
o No more than $10,500 for family coverage (for 2006)
Both can be higher for out-of-network services Can be a self-insured employer plan
What Non-HDHP Coverages are Allowed?What Non-HDHP Coverages are Allowed? Coverage for accidents, disability, dental care,
vision care, or long term careo HRA or FSA coverage would be impermissible non-HDHP
coverage if it can be used on a first-dollar basis to cover medical expenses generally
o Guidance indicates that separate drug plans that are not subject to the high deductible are not allowed without losing HDHP status.
Permitted insuranceo Workers’ compensation, tort liabilities, liabilities relating to
ownership or use of property, insurance for specified diseases, per diem hospitalization insurance
How are HSAs Funded?How are HSAs Funded? Contributions by an
eligible individual Contributions by an
employer of an eligible individual
Rollover contributions from an Archer MSA or another HSA (one per year; must roll w/in 60 days; not subject to annual contribution limits)
Contributions must be in cash
Contributions can only be made for those months that a person is an eligible individual
Contributions are fully vested and portable
Can be through a cafeteria plan
What are Contribution Limits for HSAs?What are Contribution Limits for HSAs? Maximum monthly amount is 1/12 of the annual
contribution limit for HSAs Annual limits (no limits for rollovers)
o For single coverage, lesser of the HDHP’s deductible (min. of $1,050) or $2,700 (for 2006)
o For family coverage, lesser of HDHP’s deductible (min. of $2,100) or $5,450 (for 2006)
o Additional catch-up contributions (up to $500 annually) for eligible individual age 55 to 65 ($700 in 2006)
What are Contribution Limits for HSAs?What are Contribution Limits for HSAs? Special rules for married people
o If either spouse has family coverage, both are treated as having it
o If each has family coverage, then contribution limit is based on lower deductible of the two and limit is split between the spouses, unless they agree otherwise
o Both spouses can make the catch-up contributions
Excess contributions are taxable plus 6% penalty tax if not distributed by tax deadlineo If returned, then only earnings on excess are taxed
(with no penalty tax)
What are the Tax Effects for Contributions?What are the Tax Effects for Contributions? Contributions for a taxable year may be made during the
year up to tax filing deadline and appreciate tax-free while in the HSAo Pre-funding issues
o Wait-and-see approach Contributions are deductible by the eligible individual in
determining gross income (above-the-line deduction) Employer contributions are deductible by employer;
excludable from employee’s income; not subject to withholding for FICA, FUTA, and RRA; and subject to a 35% excise tax if not made in comparable amounts to comparable employees
What Rules Apply to Distributions?What Rules Apply to Distributions? Distributions may be taken any time (even if not
currently an “eligible individual”) Distributions for qualified medical expenses of
eligible individual, spouse, and dependents are excludible from income
Distributions for any other purpose are subject to regular tax plus a 10% penalty tax
Distributions made after death, disability, or attaining age 65 are not subject to 10% penalty tax
How Can Accounts be Transferred?How Can Accounts be Transferred? Upon divorce
o Spouse can become account holder
o Transfer is not a taxable event
After deatho If spouse is HSA death beneficiary, then spouse
becomes account beneficiary, and death is not a taxable event
o If death beneficiary is non-spouse, HSA no longer exists and beneficiary gets taxed on HSA’s fair market value
What are Qualified Medical Expenses?What are Qualified Medical Expenses? Medical expenses defined
in IRC Section 213(d) Many out-of-pocket
medical care costs Prescription drug costs
and OTC drugs (as permitted by Rev. Rul. 2003-102)
Certain insurance premiumso Long-term care insurance
o COBRA premiums
o Health insurance while on unemployment
o Over age 65 – also any health insurance other than a Medicare supplemental policy
Health Savings Account ProductsHealth Savings Account Products Over 125 different HSA products are currently
being offered by HSA vendors nationwide o See http://greatlakeshsa.com/hsaproviders.html
Examples of vendors and products offered include:o FORTIS Financial Services
o Insurance companies
o Anthem By Design HSA, which offers an Anthem High Deductible Health Plan coupled with a Chase custodial account
Health Savings Account Products (cont'd)Health Savings Account Products (cont'd)
United Healthcare offers I Plan HSA which combines several HDHP options with a bank account or debit card issued by its own affiliate bank Exante (full HSA administration is included in the base fees)
Principal Bank, a division of the Principal Financial Group offers three different HSA products:o Principal Bank Choice Checking offers the convenience
of a checking account and debit cardo Principal HSA Mutual Funds offers 35 mutual funds
optionso Principal HSA Certificates of Deposit (CD) offers HSA
CDs in 1-year, 3-year and 5-year terms
Possible Build-Up of Savings for Families with an HSA - Various Time and Medical Expense ScenariosPossible Build-Up of Savings for Families with an HSA - Various Time and Medical Expense Scenarios
Health Savings Account Balances(Assumes a $4,000 deductible and deposit each year)
Account Balance After X Years
Age of Head of Household
Starting at 30
After Family Medical Expenses
of $1,000 Each Year
After Family Medical Expenses of $500 Each Year
Zero Family Medical
Expenses
5 Years 35 $ 17,406 $ 20,307 $ 23,208
10 Years 40 39,620 46,224 52,827
15 Years 45 67,972 79,301 90,630
20 Years 50 104,158 121,517 138,877
25 Years 55 150,340 175,397 200,454
30 Years 60 209,282 244,163 279,043
35 Years 65 284,509 331,927 379,345
Assumes 5% interest per year earned on your HSA deposits, and $4,000 is deposited each year. One Health Savings Account insurer (Medical Savings Insurance) pays 5% interest on balances in their Health Savings Accounts, and has paid that same interest rate since January 1, 1997, during the MSA pilot. Source: The HSA Coalition
Possible Build-Up of Savings for Families with an HSA - Various Time and Medical Expense ScenariosPossible Build-Up of Savings for Families with an HSA - Various Time and Medical Expense Scenarios
Health Savings Account Balances(Assumes a $2,000 deductible and deposit each year)
Account Balance After X Years
Age of Head of Household Starting
at 25
After Individual Medical Expenses
of $1,000 Each Year
After Individual Medical Expenses of $500 Each Year
Zero Individual Medical Expenses
5 Years 30 $ 5,802 $ 8,703 $ 11,604
10 Years 35 13,207 19,810 26,414
15 Years 40 22,657 33,986 45,315
20 Years 45 34,719 52,079 69,439
25 Years 50 50,113 75,170 100,227
30 Years 55 69,761 104,641 139,522
35 Years 60 94,836 142,254 189,673
40 Years 65 126,840 190,260 253,680
Assumes 5% interest per year earned on your HSA deposits, and $2,000 is deposited each year. One Health Savings Account insurer (Medical Savings Insurance) pays 5% interest on balances in their Health Savings Accounts, and has paid that same interest rate since January 1, 1997, during the MSA pilot. Source: The HSA Coalition
Average Use for Health Savings AccountsAverage Use for Health Savings Accounts On average Health Savings Account holders use
their account 4 times a year and end their first year with a balance of $840
The FactsThe Facts Fees charged by health savings account providers vary widely
(Source: HSAFinder.com survey, July 2005)
Fees range from $235 for the first year (Equity Trust Co.), to $0 (American Chartered Bank, Capitol Bank, Blackhawk Bank and First American Bank)
HDHPs that qualify to be partnered with an HSA are available through over 100 insurance companies currently
Most HDHPs have deductibles between $1,050 - $5,100 for singles and $2,100 - $10,200 for families
The Facts (cont'd)The Facts (cont'd)
2004o 438,000 people covered under HSA-type planso 113,000 tax returns reporting HSA deductions
Nowo 3.2 million covered by HSA-type plan (7x increase)o 31% -- previously uninsuredo 33% -- small business not previously offering coverageo $1 billion invested in HSAso 42% - number of individuals or families with incomes
below $50,000 buying HSA-type coverage
Source: US Treasury Department Fact Sheet: “Dramatic Growth of Health Savings Accounts (HSAs)” (March 2006)
The Facts (cont'd)The Facts (cont'd)
Most commonly, monthly premium prices range from $51 to $100
61% of the employers are likely to offer HSAs in the near future (Source: Hewitt and Associates’ survey of 270 employers regarding HSAs)
One-third of the employers currently had the required benefit design structure in place to do so (Source: Hewitt and Associates’ survey of 270 employers regarding HSAs)
Several states have passed laws making individual contributions to HSAs tax-free and another 10 states have introduced legislation to do the same
Market response to HSAs with HDHP products has been modest
FSA HRA HSAEmployer-established
No restrictions for Medicare-eligibles
Employer-established
No restrictions for Medicare-eligibles
Must be covered by high deductible health plan (HDHP) which can be self-insured and no other plan that is not an HDHP
May not be Medicare-eligible
“Permitted insurance” allowed
EligibilityEligibility
FSA HRA HSAGenerally employee contributions through a 125 plan
No trust required – usually employer’s general assets
Must be employer contributions
No trust required – usually employer’s general assets
May be employee or employer contributions (can be through a 125 plan)
Funded trust required that must be maintained by a qualified HSA custodian
FundingFunding
FSA HRA HSAOnly qualified medical expenses
NO insurance premiums
Qualified medical expenses
Insurance premiums
Qualified medical expenses
Pre-age 65: (1) COBRA, long term care, while receiving unemployment compensation (all with no tax); (2) anything (with normal income tax plus a 10% penalty tax)
Post-age 64: (1) any health insurance except Medicare supplemental policies (with no tax); (2) anything (with only normal income tax)
Expense FlexibilityExpense Flexibility
FSA HRA HSANo, but employers generally allow accounts to be used post-employment for expenses incurred while employed
Subject to COBRA
No, but reimbursement for medical expenses of the former employee is permitted (e.g., to fund retiree health benefits)
Subject to COBRA
HSA belongs to the individual account beneficiary and is fully portable from employer to employer
Not subject to COBRA
PortabilityPortability
FSA HRA HSAUnused account balances are forfeited at end of taxable year
Unused account balances may accumulate and roll over to next year (at employer’s discretion)
Unused account balances accumulate and roll over to next year
May accept rollover contributions from Archer MSAs and other HSAs
Annual RolloversAnnual Rollovers
FSA HRA HSANone – limits are defined by employer and limited by nondiscrimination rules
None – limits are defined by employer and limited by nondiscrimination rules
Individual HDHP: lesser of 100% of deductible or $2,700
Family HDHP: lesser of 100% of deductible or $5,450
Contributions contingent on having a HDHP and none allowed post-65
Employer contributions subject to a comparability requirement (35% tax penalty if violated)
Contribution LimitsContribution Limits
FSA HRA HSAEmployee and employer contributions not taxable
Reimbursements not taxable if for qualified medical expenses (no other reimbursements allowed)
Employer contributions are not taxable
Reimbursements not taxable if for qualified medical expenses (no other reimbursements allowed)
Employer and employee contributions are not taxable
Reimbursements are not taxable if for qualified medical expenses
Other distributions subject to normal income taxes and 10% penalty (penalty does not apply after age 65, death, or disability)
Tax EffectsTax Effects
FSA HRA HSADivorced/surviving spouse and dependents eligible for COBRA
Divorced/surviving spouse and dependents eligible for COBRA
Death: spouse becomes HSA holder and HSA continues; other beneficiary receives distribution and HSA ceases
Divorce: HSA interest transferred to divorced spouse without tax
Death and DivorceDeath and Divorce
