HSAs - Are They Right For You?

In today's environment of rising health insurance costs, owners must be creative in structuring benefits for employees in order to remain competitive in the marketplace. One option that has been made available, and that is increasing in popularity are HSAs (Health Savings Accounts). These plans are "consumer-directed health plans," where more of the decisions on how to spend health care dollars are placed in the hands of the employee, rather than with the employer or insurance company.

HSAs are coupled with high-deductible health insurance plans (HDHPs), which are generally much more reasonably priced than HMOs or plans with low annual deductibles. Contributions result in medical expenses being deductible from the first dollar rather than having to exceed the 7.5% of AGI (adjusted gross income) floor for out-of-pocket medical expenses on an individual's income tax return (if they itemize deductions).

Advantages of an HSA from an individual's perspective are:

• Reduced health insurance premiums
• More control over medical spending
• Ability to set aside future funds on a tax-favored basis (earnings on funds in these accounts are not taxed - similar to retirement accounts)
• All HSA balances are immediately vested. Once a contribution is made, the employer has no right to control the funds
• HSAs follow the individual (they are "portable"), they do not stay with the employer
• No use-it or lose-it rules. If there are unused funds at the end of the year, they carry over to be used on future allowable expenses

From an employer's perspective, advantages include:

• More predictable financial obligation relating to health care costs
• Opportunity to restructure cost-sharing between the employer and employees
• For small employers, this may be their first opportunity to be able to offer a health plan to employees for the first time

Disadvantages from an individual's perspective can be:

• A feeling of inadequate coverage due to some HDHPs not providing for preventative care (although HDHPs are permitted to offer preventative care, not all do)
• If usage is high, funds will not be available to carry over from year to year and possibly not provide the funds desired to be carried over into retirement
• Funds are taxable upon death of the account owner if the beneficiary is other than the decedent's spouse
• No losses in account value are deductible
• Eligibility to contribute to an HSA ends on the day the account owner becomes enrolls in Medicare

Employers may not like HSAs due to:

• Administrative resources will be necessary to implement and administer an HSA option and to educate human resources personnel regarding the benefit
• Opposition from employees not wishing to change from the existing coverage and an unwillingness to switch

An HSA is a custodial account created exclusively for the purpose of paying the qualified medical expenses of the account owner. The written governing instrument creating the trust or custodial account must meet all of these requirements:

• Regular HSA contributions must be made in cash
• For 2007, HSA contributions made for a taxable year are no longer limited to 100% of the plan's deductible for that year
• For 2007, the maximum plan contribution is $2,850 for individual and $5,650 for family coverage.

Employers or employees may make contributions to the plan up to the annual limitations mentioned above. The HSA is generally exempt from tax (earnings on amounts in an HSA are not includable in gross income while held as an HSA).

An individual is permitted to receive distributions from an HSA at any time. Distributions to pay medical expenses of an account owner, spouse, or dependent are not subject to tax. Distributions made for non-qualified purposes may be subject to a 10% additional tax unless an exception applies or the account owner reaches 65.

Given the rising cost of healthcare, it is nice to have options for providing some benefit for employees while keeping a reasonable control on Company contributions. Please consult your tax and/or investment advisor prior to setting up this type of benefit to ensure the desired results are achieved.