The Medicare Prescription Drug Improvement, and Modernization Act of 2003 became
effective January 1, 2004. The provision of the Act that added Section 223,
Health Savings Accounts, to the Internal Revenue Code (IRC), received, at first,
very little attention. In the ensuing months, however, it was given major media
Health savings accounts (HSAs) are now being viewed as a significant healthcare
development for the new "ownership" society, and one that provides
employers with a cheaper way of providing employee health benefits. The New
York Times noted last fall that, because small businesses were showing an
interest in HSAs, the group insurance market for small businesses was taking
notice and creating new products.
Need for Continuing Clarification
Although Section 223 of the IRC is only several pages long, it is far from
self-explanatory and has raised many issues requiring interpretation. The Internal
Revenue Service (IRS) has provided guidance on several occasions, but each set
of answers seems to raise more questions. Recently, the IRS revised both Publication
969, Health Savings Accounts and Other Tax-Favored Plans, and its list
of "frequently asked questions" (FAQs) about HSAs. Here, we will look
at some of these IRS revisions, with an emphasis on rules governing employer
participation in HSAs.
Benefit for Employers
In general, an HSA is a tax-exempt trust, or custodial account, set up
for the purpose of paying current "qualified medical expenses" and
also for the purpose of saving--
on a tax-free basis--money to pay for future medical and retiree health
expenses. (According to the latest FAQs, the difference between an HSA "custodian"
and an HSA "trustee" is minor and is governed by state law. In brief,
the trustee has some discretionary, fiduciary authority and the custodian doesn't.)
An HSA can be established only for the benefit of an individual who is covered
under a "high deductible health plan" (HDHP). According to the recent
FAQs posted by the IRS, an HDHP is sometimes referred to
as a "catastrophic" health insurance plan and is an inexpensive health
insurance plan that generally doesn't pay for the first several thousand
dollars of healthcare expenses (i.e., the deductible) but will usually provide
coverage after that. In order to open an HSA, the HDHP minimum deductible must
be at least $1,000 (self-only coverage) or $2,000 (family coverage). The annual
out-of-pocket expenses (including deductibles and co-pays) cannot exceed $5,100
(self-only coverage) or $10,200 (family coverage). HDHPs can have first dollar
coverage (no deductible) for preventive care and apply higher out-of-pocket
limits (and co-pays and coinsurance) for out-of-network services.
Since an HDHP costs much less than a traditional policy because of the high
deductible, this makes HSAs of interest to employers seeking to provide an employee
health benefit that won't bankrupt the company.
Benefit for Employees
Putting aside the negative factor
of the high deductible, the HSA offers the account beneficiary of
an HSA many positives, including the following:
- The HSA beneficiary may claim
a tax deduction for contributions that an employee, or someone other than
his employer, makes
to his or her HSA, even if the employee does not itemize his or her deductions
on Form 1040.
- The beneficiary may exclude from the gross income contributions made to
his or her HSA
by the employer (including
contributions made through a cafeteria plan).
- The contributions remain in the beneficiary's account until he or she
- The interest or other earnings
on the assets in the account
- Distributions from the account may be tax-free if they are used
to pay qualified medical expenses.
- The HSA is portable; it stays
with the beneficiary if an employee changes employers
or leaves the workforce. The employee fully owns the
contributions in the account as soon as they are deposited; the employer does
not own his employees' HSAs and has no control over how the money in
the HSAs is spent. Furthermore, even though an individual has
an HSA but no longer maintains HDHP coverage, the money
that is already in the HSA may continue to be withdrawn tax-free to pay for
qualified medical expenses. There is no time limit on using the funds.
Recently revised Publication 969 discusses, among many other things, the rules
employers must follow if they decide to make HSAs available to their employees.
First, employers are advised that if they want their employees to be able to
have an HSA, the employees must have HDHPs. Employers can provide no additional
insurance coverage other than those exceptions listed in Pub. 969 under "Other
The exception for "other health coverage" permits additional coverage
for the following items:
(1) liabilities incurred under workers' compensation laws, tort liabilities,
or liabilities related to ownership or use of property; 2) a specific disease
or illness; and 3) a fixed amount per day (or other period) of hospitalization.
Additional coverage also may be for accidents, disability, dental care, vision
care, and long-term care.
And Comparability Rules
Employers making contributions to HSAs on behalf of employees must be aware
of the so-called comparability rules. Under these rules, if the employer decides
to make contributions, he or she must make comparable contributions to the HSAs
of all "comparable participating employees." Comparable participating
- Are covered by the employer's HDHP and eligible to establish
- Have the same category of coverage (either self-only or family
- Have the same category of employment (either part-time
The employer's contributions are comparable if they are either:
(1) the same amount, or (2) the
same percentage of the annual deductible limit under the HDHP covering the employees.
Pub. 969 specifically states that: "The comparability rules do not apply
to contributions made through a cafeteria plan."
Cafeteria plans, or salary reduction plans, also known as Section 125 plans,
must meet a different set
of rules. Under these rules, contributions (both from the employer and/or the
employee) must meet "nondiscrimination" rules.
These rules require the employer
to ensure that contributions do
not favor higher compensated employees.