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Taking Another Look at Health Savings Accounts

By:

Barbara Weltman

Favorable tax law changes for health savings accounts, combined with ever-rising premiums for traditional medical coverage, make HSAs worthy of consideration now. One research database predicts that HSAs are poised for aggressive growth and that 30 million people will be covered by HSAs by 2009. Will they work in your company?

Health Savings Accounts (HSAs) are a way for small businesses to provide affordable health coverage for their staff. They combine high-deductible health plans, or HDHPs (which are substantially less costly than traditional coverage), with IRA-like savings accounts. Contributions are tax deductible, earnings are tax deferred, and withdrawals to pay medical costs are tax free; unused amounts continue to grow from year to year. Some dramatic changes in the rules for HSAs make them more attractive than in the past and, according to Mintel, new plans could explode in the coming years.

Higher contributions
The Tax Relief and Health Care Act of 2006, which was enacted in December 2006, created key changes for HSAs, one of which was to move up the date that contribution limits for the following year must be announced. Here are key changes:

Contributions can be made up to a fixed amount--in 2007, $2,850 for self-only coverage; $5,650 for family coverage, with an additional "catch-up" contribution of $800 for those age 55 or older by the end of the year; in 2008, $2,900 for self-only coverage; $5,800 for family coverage, and a $900 catch-up contribution. (Limits are adjusted annually for inflation and are announced June 1 each year.) In the past, contributions could not exceed the amount of the deductible under the HDHP.

Contributions need not be prorated for part-year participation in the HSA, as long as the HDHP is maintained for a minimum of 12 months.

IRA funds can be moved to an HSA tax free (within strict limits). IRA distributions to pay medical costs are taxable, while disbursements from an HSA for this purpose are tax free.

Funds in flexible spending accounts (FSAs) and health reimbursement accounts (HRAs) can be rolled over tax free to HSAs (through January 1, 2012). Maximum transfer: The lesser of the account balance at the time of transfer or on September 12, 2006. Caution: The HDHP must be maintained for at least 12 months following the rollover or the funds become taxable as ordinary income and subject to a 10% penalty.

Note: While the contribution limits for 2008 will rise, the minimum deductible for HDHPs will remain constant at $1,100 for self-only coverage, or $2,200 for family coverage. This means that allowable contributions are now nearly triple the amount of the deductible, providing more funds to pay other out-of-pocket medical costs on a tax-advantaged basis.

Acceleration of contributions
Contributions to the HSA can be made by the employer, employee, or a combination of both--the party making the contribution gets the deduction. Typically, contributions are stepped in throughout the year. Contributions can be made as late as the due date of the return, without regard to extensions: April 15, 2008, for 2007 contributions.

The IRS has proposed to allow employers to accelerate all of part of contributions for the year on behalf of employees who have incurred medical expenses in excess of the accumulated contributions to date. This will help employees meet unexpected medical costs.

To incorporate this acceleration provision within a company's HSA, the option must be available on an equal and uniform basis to all eligible employees throughout the year. The employer must set up reasonable uniform methods and requirements for acceleration of contributions and the determination of medical expenses that would warrant acceleration.