Originally published April/May 2005
Health Savings Accounts ("HSAs") were created by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (Public Law 108-173; 117 Stat. 2446), signed into law by President Bush on December 8, 2003. Financial institutions may be interested in offering this relatively new product, or may be approached by an entity such as an employer seeking a trustee or custodian for an HSA product that it wishes to make available to its employees with high-deductible health plans. Accordingly, this article provides a brief overview for financial institutions who may be interested in offering HSA services.
Purpose and Contribution Limits. HSAs are designed to help individuals and families who have high-deductible health plans save for future qualified medical and retiree health expenses on a tax-free basis. Such individuals may contribute up to the lesser of the deductible for the health plan or $2,650 per year for individual coverage, or the lesser of the deductible or $5,250 per year for family coverage. (The dollar amounts will be indexed each year.) The trustee/custodian is not responsible for monitoring the amount of contributions and determining whether they exceed the annual contribution limit. Rather, the responsibility is that of the accountholder, who must request the withdrawal of any excess contribution and include such amounts in calculating taxable net income. Additionally, the trustee/custodian is not required to determine whether a distribution is for the payment or reimbursement of qualified medical expenses; this responsibility also falls to the accountholder.
HSAs are similar in intent and function to the Medical Savings Accounts ("MSAs") which existed at the time the enabling HSA legislation came into effect, but differ in certain important functional respects from MSAs (which, with limited exceptions, no longer can be established). At the present time, the Internal Revenue Service ("IRS") is continuing to adopt rules, requirements, and forms governing HSAs, so the administrative landscape for HSAs is continuing to change.
Qualifying as Trustee or Custodian. Banks, credit unions, or any other entity that meets the IRS standards for serving as a trustee or custodian for an Individual Retirement Account ("IRA") can also be a trustee or custodian of an HSA. Insurance companies also can be HSA trustees or custodians. In addition, any entity already approved by the IRS to be an IRA trustee or custodian is automatically approved to be an HSA trustee or custodian.
Model Contract. The IRS has prepared model trust account and custody account agreements, IRS Forms 5305-B and 5305-C. The trustee/custodian may use one of the IRS’s standard forms, or may modify the form to include additional provisions that address, for example, investment powers, voting rights, amendments and termination, removal of the trustee/custodian, withdrawal procedures (including minimum allowable amounts and frequency), exculpatory provisions, and any state law requirements.
Investment Limits. There are limitations on the investment of funds held in the HSA. For example, funds may not be invested in life insurance contracts or in collectibles such as works of art, rugs or antiques, certain coins, or similar assets. The assets of the HSA may not be commingled with other property, except in a common trust fund or common investment fund. Moreover, the trustee/ custodian may not borrow against or pledge the assets in an HSA, or engage in any other prohibited transaction described in Internal Revenue Code section 4975.
Reporting Requirements. The trustee/custodian is required to submit reports regarding contributions (IRS Form 5498-SA) and distributions (IRS Form 1099-SA) to the IRS. These forms will be familiar to many financial institutions as a result of the reporting requirements of other products and services.
Other Regulatory Issues: Broker-Dealer and Investment Adviser Rules. HSAs offer the advantage of allowing account holders to invest their account balances in a diverse array of (sponsorselected) investments, but this feature triggers several discrete bank and securities regulatory consequences. While serving as a trustee/custodian of an HSA is reasonably straightforward from a regulatory perspective, other issues not specific to HSAs should be kept in mind. Broker-dealer and investment adviser rules may apply depending on the relationship between the bank and HSA customer—for example, whether the HSA accountholder comes to the bank through another entity, such as an employer, or whether the HSA accountholder opens his or her HSA directly with the bank. If other entities, such as an employer, health plan provider, employee benefits consultant, etc. are involved in the provision of HSAs, each entity’s rights and responsibilities with respect to the other participants and the accountholder should be specified in a series of contracts that will assist in, among other things, preventing situations in which an entity is required to do something that is not permissible under federal banking, tax, or securities laws.
For example, the trustee/custodian should consider whether it is "effecting" any transactions in securities within the meaning of the broker-dealer statutory and regulatory provisions of the Securities Exchange Act of 1934 ("Exchange Act") and the implementing regulations of the Securities and Exchange Commission ("SEC").
A trustee/custodian that is a bank may be exempt from brokerdealer registration under one or more of the exemptions to section 3(a)(4) of the Exchange Act. Although banks’ exemption from the definition of "broker" has been extended to September 30, 2005, the SEC is expected to issue a final Regulation B implementing section 3(a)(4) of the Exchange Act, and banks may have to choose between registering as a broker-dealer or transferring out some functions incidental to acting as an HSA trustee/custodian to a registered broker-dealer. Financial institutions other than banks must be aware of the broker-dealer regulatory framework and the customer relationship that is created and carefully structure their HSA programs to minimize regulatory burdens. Atrustee/custodian that is a "bank" as defined in section 3(a)(6) of the Exchange Act should not be considered an investment adviser to HSA accountholders when it provides a menu of mutual fund investment options for the HSA assets, because banks are generally exempt from the definition of "investment adviser" under the Investment Advisers Act of 1940 (unless they serve as investment advisers to registered investment companies). As noted above, other financial institutions should structure their HSA programs to avoid unnecessary regulation.
Conclusion
HSAs are a relatively new product, but they may fit in well with the other retirement and savings products offered by a financial institution. While there are regulatory considerations to consider in structuring an HSA program and offering HSA services, it should be relatively straightforward to navigate the regulatory frameworks implicated by this product, so long as such considerations are kept in mind from the beginning of the product development process.
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