Tucked inside last year’s Medicare reform law providing drug coverage to seniors was a little-noticed but important provision which gives employers the opportunity to offer employees greater health coverage and financial security.
The law authorized a new funding arrangement known as Health Savings Accounts, which, when paired with a high deductible health insurance plan, let employees set aside dollars for medical expenses on a tax-favored basis.
Although the ink on the law is barely dry, insurers are already rolling out new HSA products in response to employer demand for cost-efficient solutions that provide employees with greater choice and tools to help them better manage their health care dollars. HSAs may be particularly attractive to smaller employers because they can cost less than other managed care plans.
Employees under the age of 65 who are covered by a “qualified high-deductible health plan” are eligible to participate in HSAs. Contributions to the account can be made by the employer or employee, with employee contributions coming through payroll deductions.
To encourage widespread participation among both plan sponsors and employees, Congress built several tax advantages into HSAs. For example, employee contributions are tax-deductible, and employer contributions are not considered taxable income for employment tax purposes.
Similar to Individual Retirement Account (IRA) contributions, HSA contributions and any earnings on those contributions grow tax-free. But unlike an IRA, HSA withdrawals are also tax-free if the money is spent for “qualified medical expenses” incurred by the employee or his or her spouse or dependents, such as doctor visits, prescription drugs, hospital costs, and vision and dental exams.
Tax-free withdrawals are also allowed for long-term care insurance premiums, COBRA premiums and other purposes specified in the law.
Over time, employees have the potential to accumulate significant amounts in their HSAs that can be used to pay for medical expenses in retirement. The account funds can be invested in interest-bearing assets, including mutual funds or stocks, where they can grow on a tax-free basis.
Additionally, any unused account balance can be carried over from one year to the next and from employer to employer, as long as a high deductible plan accompanies the HSA in the new plan offering.
Of course, like any group benefit regulated in part by the tax code, HSAs come with several qualifications. For instance, the health insurance policy must have a minimum annual deductible of $1,000 for an individual and $2,000 for a family. Contributions are limited to the amount of the policy’s annual deductible, subject to a cap of $2,600 for individuals and $5,150 for families.
These limits are indexed for inflation in future years. HSAs can also be used to pay for nonqualified health expenses or withdrawn in cash, but will become taxable income and subject to an additional 10 percent tax penalty.
HSAs compare favorably in some respects to flexible spending arrangements (FSAs) and other health spending mechanisms. For example, there is no “use it or lose it” provision (common with FSAs), so funds can be rolled over from year to year. Additionally, since HSAs are owned by the employee, not the employer, they go with the employee who changes or loses his or her job.
Although they have just been hatched, HSAs offer a promising option in today’s consumer-driven health care marketplace.
Paul Martino is vice president of sales and service, covering Illinois and Wisconsin. He is responsible for managing sales and client management for Aetna’s middle market segment, which includes businesses with 51 to 3,000 employee lives. For more information, contact him at [email protected] or (312) 928-3754.
