Health Savings Accounts (HSAs)

With the rising cost of health insurance, many people have begun to seek alternative ways of paying for medical expenses. One such approach that is gaining popularity in today’s market is the pairing of a Health Savings Account (HSA) with a High Deductible Health Plan (HDHP). The questions and answers presented below provide an overview of how this tax-favored strategy works.

1. What is a Health Savings Account (HSA)?
2. What is a High Deductible Health Plan (HDHP)?
3. Who is eligible for an HSA?
4. What other types of health coverage can an individual have without losing eligibility for an HSA?
5. Who may contribute to an HSA?
6. How much may be contributed to an HSA?
7. When and how may contributions be made to an HSA?
8. What happens when HSA contributions exceed the amount that may be deducted or excluded from gross income?
9. What is the tax treatment of HSAs?
10. What is the tax treatment of earnings on amounts in an HSA?
11. How are the distributions from an HSA taxed?
12. What are the “qualified medical expenses” that are eligible for tax-free distributions?

1. What is a Health Savings Account?

A Health Savings Account (HSA) is a trust account that you can establish for the purpose of paying qualified medical expenses for yourself, your spouse, and your dependents on a tax-free basis. The contributions you make to an HSA are interest bearing, they can be invested, and unused contributions roll over from year to year, making these accounts extremely attractive.

In order to take advantage of an HSA, you must be covered by a High Deductible Health Plan (HDHP). Since a High Deductible Health Plan generally costs less than a more traditional health plan, you can deposit the money you save on your insurance premium in a Health Savings Account.

For more information about Health Savings Accounts, visit www.irs.gov.

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2. What is a High-Deductible Health Plan (HDHP)?

Sometimes referred to as a “catastrophic” health insurance plan, a High Deductible Health Plan (HDHP) is a health insurance plan that meets specific guidelines that are determined by the Internal Revenue Service each year. To be used in conjunction with an HSA, the HDHP minimum deductibles and maximum out-of-pocket costs in 2012 must meet the requirements shown below.

In 2013, the minimum deductibles and maximum out-of-pocket limits will be increased as shown in the table below.

HDHPs can apply higher out-of-pocket limits (and copays & coinsurance) for out-of-network services.

How a High Deductible Health Plan Works

When you enroll in a High Deductible Health Plan, you must pay all of the medical expenses you incur until you have satisfied the deductible, with the exception of expenses associated with preventive care, which, under some HDHPs, are not subject to the deductible. The health plan will generally cover all or a high percentage of expenses after you have met the deductible. (The percentage of expenses paid by the health plan after the deductible is met varies according to the plan design chosen.)

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3. Who is eligible for an HSA?

An “eligible individual” is a person who:

• Is covered under a High Deductible Health Plan;

• Is not also covered (whether as an individual, spouse or dependent) by any other health plan that is not a high-deductible health plan, with some exceptions, which are described below;

• Is not eligible for Medicare benefits; and

• May not be claimed as a dependent on another person’s tax return.

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4. What other types of health coverage can you have without losing eligibility for an HSA?

You can remain eligible for an HSA even if, in addition to a High Deductible Health Plan, you have any one or more of the following:

• Insurance under which substantially all of the coverage relates to liabilities from Workers’ Compensation laws, torts, or ownership or use of property (such as automobile insurance);

• Insurance for a specified disease or illness;

• Insurance that pays a fixed amount per day (or other period) for hospitalization;

• Coverage, whether through insurance or otherwise, for accidents, disability, dental care, vision care, or long-term care;

• Coverage under an Employee Assistance Program (“EAP”); and

• A discount card that enables you or your dependents to obtain discounts for health care services or products at managed care market rates.

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5. Who may contribute to an HSA?

An eligible individual, a family member, or any other person may make contributions to an HSA on behalf of an eligible individual. Contributions by one individual or entity do no preclude contributions by others, provided they do not exceed annual contribution limits.

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6. How much may be contributed to an HSA?

Two types of contributions may be made to HSAs, regular and catch-up contributions. Both have annual limits.

An individual who enrolls in an HSA-eligible plan in a month other than January may make the maximum HSA contribution for the year, provided that he or she remains in an HSA-eleigble plan for a 12-month period following the lastl month of of the year of the first year of eligibility.

NOTE: In order to be eligible to make a maximum annual contribution, an individual must be enrolled in a qualified HDHP the entire month of December, and the HSA must be opened by December 1.

Regular Contributions

2012

Effective January 1, 2012, the maximum amount you can contribute to an HSA was $3,2050 for individual-only coverage and $6,250 for family coverage, excluding catch-up contributions for those 55 years and older.

2013

Effective January 1, 2013, the maximum amount you can contribute per year is $3,250 for individual-only coverage and $6,450 for family coverage, excluding catch-up contributions for those 55 years and older.

Catch-up Contributions

Catch-up contributions may be made by individuals who are at least 55 years of age, but not yet eligible for Medicare.

2012

In 2012 eligible individuals could contribute an additional $1,000 to an HSA.

Note: If a spouse was also 55 or older, a second HSA may have been established and a second catch-up contribution of $1,000 may have been made to that account if desired.

2013

In 2013 eligible individuals may contribute an additional $1,000 to an HSA.

Note: If a spouse is also 55 or older, a second HSA may be established and a second catch-up contribution of $1,000 may be made to that account if desired.

An individual may make the entire annual catch-up contribution, provided he or she has attained age 55 before the close of the taxable year.

Contribution Summary

The contribution limits for 2012 are summarized in the table below. This limit is subject to change each year.

The contribution limits for 2013 are summarized in the table below. This limit is subject to change each year.

When is Prorating Required?

Prorating is required to avoid tax penalties when an individual does not maintain HSA-compatible coverage through December 31st of the following year.

Examples of Prorating Contributions

Coverage Type	Coverage Begins	Coverage Ends	Allowed 2012 Contribution
Individual	1/1/2012	12/31/2012	$3,050
Individual	7/1/2012	12/31/2012	$3,050
Individual	4/1/2012	7/1/2012	$775
Individual	11/1/2012	11/2/2012	$258.33

Mid-year Coverage

If your new HSA-compatible coverage begins in July of a given year, you are eligible to contribute the maximum amount for that year provided that you maintain coverage until December 31st of the following year.

Health Plan Status Change

If you begin the year with family coverage and switch to single coverage in July of that year, you are eligible to contribute half of the family coverage contribution maximum and half of the individual coverage contribution maximum.

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7. When and how may contributions be made to an HSA?

Contributions to an HSA may be made at any time during a calendar year and until the filing date for federal income tax returns, normally April 15 of the following year. Thus, contributions could occur over a 15½ month time span (e.g., from January 1, 2012, through April 15, 2013), provided they do not exceed the allowable annual limit described above. Contributions to HSAs may generally be made by cash, check or bank transfer.

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Contributions exceeding annual limits might occur for a number of reasons, including failure of an employee to take employer contributions into consideration, early deposits that incorrectly anticipated continuing eligibility and mathematical errors. If an excess contribution and any earnings on it are withdrawn by the filing date for the federal income tax return for the year, the individual will not be subject to a penalty. Otherwise, the excess contribution will be subject to a 6% excise tax each year until it is withdrawn.

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9. What is the tax treatment of HSAs?

Individuals who contribute to their HSAs may claim a deduction on their federal income tax. The deduction is “above-the-line,” that is, it is made in determining adjusted gross income, which lowers the income on which an individual pays taxes. It may be taken by all taxpayers, even those who claim the standard deduction instead of itemizing deductions. Keep in mind, however, that any person who may be claimed as a dependent on another taxpayer’s return may not claim a deduction for a contribution to an HSA.

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10. What is the tax treatment of earnings on amounts in an HSA?

Earnings on amounts in an HSA are not taxable prior to distribution from the HSA.

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11. How are distributions from an HSA taxed?

Distributions from an HSA for qualified medical expenses are generally excluded from income for Federal income tax purposes if such expenses are not covered by the High Deductible Health Plan or otherwise. Distributions used for any other purpose are includible in income and will be subject to an additional 10% premature distribution penalty tax. This 10% penalty tax does not apply to distributions made after your death, disability or attainment of age 65.

If the account beneficiary is no longer an eligible individual (e.g., the individual is over age 65 and entitled to Medicare benefits, or no longer has an HDHP), distributions used exclusively to pay for qualified medical expenses continue to be excludable from the account beneficiary’s gross income.

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12. What are the “qualified medical expenses” that are eligible for tax-free distributions?

Funds in your HSA are available to help pay for medical expenses incurred prior to meeting the deductible, as well as certain qualified medical expenses not covered under the health plan.

The term “qualified medical expenses” are expenses paid by the account beneficiary, his or her spouse or dependents for medical care as defined in section 213(d) of the Internal Revenue Code (including nonprescription drugs as described in Rev. Rul. 2003-102, 2003-38 I.R.B. 559), but only to the extent that the expenses are not covered by insurance or otherwise. The qualified medical expenses must be incurred only after the HSA has been established.

In general, health insurance may not be purchased with HSA funds. There are, however, four exceptions. HSA funds can be used to pay for:

1) A health plan during any period of continuation coverage required under any federal law;

2) A qualified long-term care insurance contract;

3) A health plan during a period in which the individual is receiving unemployment compensation under any federal or state law; and

4) For individuals over age 65, premiums for Medicare Part A or B, a Medicare HMO and/or the employee share of premiums for employer-sponsored health insurance, including premiums for employer-sponsored retiree health insurance.

To view a partial list of qualified medical expenses that can be reimbursed from a health savings account (HSA), click here.

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