United States: Health Savings Accounts - A Different Option for Employers

Health savings accounts have received a lot of media attention, but, so far, employers have been slow to embrace this new approach for providing health care coverage for employees. The basic concept involves a high-deductible health plan (HDHP), coupled with a tax-favored, portable individual health savings account (HSA) that allows individuals to save for future health care expenses. The HSA may be funded by the individual, the employer or both. Withdrawals from the HSA for "qualified medical expenses" are tax-free. Contributions to and earnings on the account that are not needed for qualified medical expenses can accumulate tax-free and be carried over from year to year. Ideally, this tax-free growth opportunity will be an incentive to individual account owners to become more savvy and discerning health care consumers, thereby saving themselves money and reducing utilization and overall health care costs.

An HDHP coupled with HSAs could lead to radical changes in the way employees perceive and use their health care benefits. But this approach may also require significant changes to the way employers conceptualize and manage their health care benefits. Some of the things employers should keep in mind when considering this approach are outlined below.

An HSA may be established and contributed to only by or for an individual who:

• is covered by an "eligible high deductible health plan," and
• with certain limited exceptions, has no other health care coverage.

An "eligible" HDHP is a plan having an annual deductible of $1,000 for employee-only coverage and $2,000 for family coverage (although plans can have lower (or no) deductibles for preventative care). Although the deductible amounts are indexed, the IRS recently announced that these deductible limits would not change for 2005. Eligible HDHPs also must have maximum out-of-pocket limits for 2005 of $5,100 and $10,000 for employee-only and family coverage, respectively. Prescription drug programs or other health insurance plans that include lower deductibles for certain benefits (including state-mandated benefits) will not qualify as eligible HDHPs.

The requirement that an eligible HDHP be the employee's only health care coverage may be the single largest impediment to widespread HSA adoption. There are exceptions for dental, vision and longterm care coverage, accident and disability insurance, and insurance covering a specific disease or condition. Recent guidance from the Treasury Department explains that certain employee assistance, disease management and wellness programs also will be excluded in determining whether individuals are eligible to establish HSAs. Individuals enrolled in Medicare may not establish or contribute to HSAs, thereby limiting their utility as a means of controlling retiree medical expenses in short term.

The IRS has recognized that the insurance marketplace needs more time to develop eligible HDHPs, and so has provided some transitional relief. Until January 1, 2006, separate prescription drug coverage will not disqualify an individual with an HDHP from establishing or contributing to an HSA, as long as the other HDHP requirements are met. In addition, high-deductible health plans might not be available in some states because state insurance laws require that health care policies provide certain benefits without regard to deductibles or below the HDHP/HSA minimum annual deductible.

The IRS transitional relief includes an exception for health plans which otherwise would qualify as eligible HDHPs except for the fact that they comply with state law requirements regarding deductibles for certain benefits. Such plans will be treated as eligible HDHPs until January 1, 2006.

HSAs may be set up by an individual or an employer, but they can only be established through a qualified HSA trustee or custodian. The IRS has clarified that in addition to banks and insurance companies, any other person or institution already approved by the IRS to be a trustee or custodian of Individual Retirement Accounts (IRAs) or Archer Medical Savings Accounts (MSAs) may be an HSA trustee or custodian. Because these products may not immediately be available locally, the IRS has created a special rule allowing short-term relief. An individual who is participating in an eligible HDHP and wishes to participate in an HSA in 2004 has until April 15, 2005 to establish and contribute to an HSA. Once the HSA is established and funded, that individual may take tax-free distributions for all qualified medical expenses incurred after the later of January 1, 2004, or the date the individual became covered under an eligible HDHP.

The maximum annual contribution that may be made to an HSA for 2005 (whether by an employer, employee or both) is the lesser of the HDHP deductible or $2,650 ($5,250 for family coverage). These maximums are indexed. Individuals between the ages of 55 and 64 may make additional "catch up" contributions in the amount of $600 per year for 2005, phasing up to $1,000 in 2009. Contributions may not be made on behalf of individuals who no longer qualify as "eligible individuals" (for instance, because they are entitled to Medicare or are no longer covered by an HDHP). Contributions made on an after-tax basis by an individual are tax deductible, even if the individual does not itemize deductions. Contributions by an employer are not included in the employee's income for purposes of federal income taxation, FUTA or FICA. Employers may also permit employees to make pre-tax contributions to an HSA through a cafeteria plan.

If an employer contributes to an employee's HSA, the new law requires that the employer make comparable contributions on behalf of all "comparable participating employees" during the same time period, or be subject to an excise tax. Contributions will be considered "comparable" if they are the same amount or the same percentage of the HDHP deductible. The IRS has clarified that "comparable participating employees" means those employees who are participating in the same HDHP during the same time period, and that the comparability rule is applied separately with respect to parttime employees. The comparability requirement does not apply to contributions through a cafeteria plan or to amounts rolled over from an Archer MSA or another HSA.

An individual may receive distributions from an HSA at any time. Distributions used to pay "qualified medical expenses" of the individual, spouse or dependents are excludible from gross income; with limited exceptions, distributions for any other purpose are includible in income and subject to an additional 10% tax. "Qualified medical expenses" generally include all expenses that are reimbursable through a flexible spending account (including over-the-counter medications). In general, HSA distributions may not be used to pay health insurance premiums, but there are exceptions. HSA distributions can be used for COBRA premiums, long-term care insurance premiums and health insurance premiums while the individual is receiving unemployment benefits. In addition, although individuals who are enrolled in Medicare can not make contributions to an HSA, they may use accumulated HSA funds to pay Medicare premiums or to pay their share of employer-sponsored health coverage, including retiree coverage.

A HDHP offered by a non-governmental employer will be an ERISA welfare benefit plan subject to all of ERISA's requirements (5500 filing, providing an SPD, etc.). The Department of Labor clarified, however, that an HSA that is offered in conjunction with an HDHP will not be considered an ERISA plan, provided the employer does not:

• require employees to establish an HSA;
• limit the ability of participants to roll over funds to another HSA;
• impose conditions on the use of HSA funds; • make or influence investment decisions with respect to HSA funds;
• represent that HSAs are an employee welfare benefit plan established and maintained by the employer; or
• receive any payment or compensation in connection with the HSA.

HSAs are part of a growing movement toward "consumer directed health care," which places more of the risk and reward of health care utilization on employees in an effort to encourage prudent buying behavior. Smaller employers or companies that have not been able to afford health benefits for their employees may find them an attractive option, as may larger employers who are willing to limit their health benefit coverage to highdeductible health plans. HSAs are controversial - opponents argue that they will attract only the healthiest and wealthiest employees, creating adverse selection problems for more traditional health plans and ultimately making the cost of health insurance more expensive for all. It is too soon to tell whether HSAs will actually reduce health care costs over the long term, but interested employers should watch the market develop and determine whether the option is right for their business.