Health Savings Accounts: The Future of Health Insurance is Now!
Health Savings Accounts:
The Future of Health Insurance is Now!
Oregon Lodging Association’s "Lodging News"
January 2004
On December 8, 2003, President Bush signed into law the Medicare Prescription Drug, Improvement, and Modernization Act of 2003(the "Act") which allows individuals under 65 years of age to establish Health Savings Accounts ("HSA") beginning January 1, 2004. HSAs are available to anyone with health insurance who is covered by a so-called high deductible health plan. A high deductible health plan is defined in the Act to mean a deductible of at least $1,000 for individuals and $2,000 for a family plan. Eligible individuals can contribute to an HSA an annual amount equal to the insurance policy’s annual deductible, subject to a cap in 2004 of $2,600 for individuals, and $5,150 for families. Amounts contributed to an HSA can be used for qualified medical expenses without any tax consequences. The following example illustrates the tremendous benefits available to those who establish an HSA for themselves, their family, or through an employer.
Assume that Bob is 35 years old and has a wife and two kids. Bob is the sole owner of the Sunshine Lodge and has 3 full-time employees. Bob cannot afford to provide health insurance to his employees. Bob’s annual deductible for his own family health insurance is $2,000 per individual with an annual $4,000 maximum family deductible. This so-called high deductible health plan can result in substantial premium savings. For example, the premiums for a standard family health insurance plan with a $250 deductible and $500 maximum family deductible might be as much as $250 – $350 per month ($3,000 – $4,000 per year) more than the premiums for a high deductible health plan, depending upon the plan benefits and the plan provider. Under the Act, Bob can contribute these premium savings to his HSA up to $4,000 annually (or in monthly increments) from Bob’s pre-tax income. This amount can then be used by any member of Bob’s family to satisfy the insurance deductible, costs associated with visits to the doctor, both prescription and non-prescription drugs, and other qualified medical services or care. Additionally, Bob is eligible to establish an HSA even though he might not be eligible to participate in a cafeteria plan as the sole owner of his small business.
While Bob’s HSA can be a valuable tool to meet family medical expenses in the first year it is established, the true benefit of the HSA becomes evident in year two and subsequent years, especially when considered as a retirement savings tool. First, Bob can continue to contribute up to $4,000 each year to the HSA. Second, amounts contributed to the HSA can be invested much in the same way as a traditional IRA so the principal can grow substantially over time. Therefore, if Bob contributes $333 per month for 30 years, and spends approximately % of that amount on qualified medical expenses, and if the unspent amounts contributed ($166/month) to the HSA grow at an annual rate of 8%, Bob’s HSA will have an accumulated balance of $235,324 by the time Bob is 65 years old. Further, this amount will be available for use without paying any taxes on either the principal or the accumulated income at any time. As you can see, an HSA can be a powerful tool to save for current medical expenses, and for future medical expenses during retirement.
Another intriguing use of an HSA is as an employee benefit. An employer can establish an HSA on behalf of an employee and can make contributions to the HSA. Using the example above, Bob would like the Sunshine Lodge to assist its employees in meeting their health insurance needs. One way for the Lodge to do this is to arrange for employees to be covered by a high deductible health plan. Whether the Lodge pays the entire premium, or just a portion, the Lodge can deduct such amounts from its gross income. Also, the Lodge can establish an HSA for each employee and make fully tax deductible contributions to the HSA on behalf of the employee, which amounts are excluded from the employee’s taxable income and which may be made though an existing cafeteria plan. Employees can even make their own individual pre-tax contributions to this HSA as long as the combined employer-employee contributions do not exceed the maximum contribution limit.
Finally, when the employee decides to stop working at the Sunshine Lodge, the employee can take the HSA with her without having to cash it in. If the employee begins working for a new employer and is covered by health insurance that is not a high deductible health plan, the employee may still invest amounts that are already in the HSA and may pay for qualified medical expenses, all without paying taxes on such amounts. However, the employee will no longer be eligible to make additional contributions to the HSA unless the employee again becomes covered under a high deductible health plan.
HSAs may also prove useful as a cost savings tool for small employers currently providing health insurance to employees. An example that appeared in a January 4, 2004, article in the Oregonian referenced monthly premium savings of approximately $135 for individuals and $391 for families under an employer’s group health plan after the employer switched from a $250 deductible to a $2,500 individual and $4,000 family deductible. While such savings will vary considerably depending upon various factors, the example is a good illustration of how an employer could pay an employee’s entire monthly premium, contribute part of the deductible to the HSA, and still save money. Also, the employee continues to receive his or her health coverage as well as a tax-free account to use for qualified medical expenses.
While HSAs are subject to various limitations not discussed in this article, the Wall Street Journal recently noted that HSAs are "an enormous improvement over most existing health insurance options, especially for the individual and small business market." We strongly agree with this analysis and encourage you to determine whether an HSA is right for you or your business.