Consider a New Health Savings Account

By Ronald J. Kaley, MBA

Health Savings Accounts, or HSA's, are new in 2004. HSA's are somewhat like IRA's, except their intended purpose is to pay medical expenses. Contributions to HSA's are deductible within limits; the earnings of HSA's are tax-free, and distributions used to pay medical expenses are tax-free. The following information will help you better understand what an HSA plan does, and then determine whether an HSA is worth exploring for you.

HSA's can only be established by eligible individuals who are covered by an HDHP (High Deductible Health Plan) and not covered under any other health plan which is not an HDHP, unless the other coverage is permitted insurance or coverage for accidents, disability, dental care, vision care, or long-term care. Eligible individuals may, subject to statutory limits, make contributions to HSA's and employers as well as other persons (e.g., family members) may also contribute (subject to maximum annual limits) on behalf of eligible individuals. An account holder gets the deduction for contributions to his HSA even if someone else (e.g., family member) makes the contributions. Employer contributions to an HSA are excludable from the employee's income and distributions from such contributions for qualifying medical expenses are tax-free.

Why establish an HSA?

• Deduct 100% of your HSA contributions from your taxable income
• Dollars in your HSA accrue interest and/or gains on a tax-free basis.
• Pay no penalties or tax when you use your HSA to pay for qualified medical expenses
• A high-deductible HSA-eligible health insurance plan typically has a lower premium than a plan with a lower deductible.
• Like an IRA, an HSA belongs to the account holder and will travel with the account holder.

What are Qualified Medical Expenses?

HSA's can be used to pay for many types of medical expenses even some often excluded on health insurance plans. However, for these expenses to qualify, you must establish an HSA before incurring any expenses. Allowable expenses include:

• Health insurance plan deductibles, co-payments, and co-insurance
• Prescription and over the counter drugs
• Dental services including braces, bridges, and crowns
• Vision care including glasses and lasik eye surgery
• Psychiatric and certain psychological treatments
• Long-term care services
• Medically-related transportation and lodging

HSA's cannot be used to pay health insurance premiums although there are exceptions for:

• Health insurance premiums if you are receiving federal or state unemployment benefits
• Premiums for COBRA qualified insurance
• Long-term care insurance premiums
• Premiums for health plans (other than a Medicare supplemental policy) for an individual age 65 or older

What insurance plans are Eligible?

For 2004, an HDHP is a health plan with an annual deductible of at least $1,000 for individual coverage ($2,000 for family coverage) and maximum out-of-pocket expenses of $5,000 for individual coverage ($10,000 for family coverage). An eligible individual must have an HDHP that does not provide benefits for any year until the annual minimum deductible for the year is satisfied. However, a HDHP may have a zero preventive care deductible or a preventive care deductible below the minimum annual deductible.

How much may be contributed to an HSA?

Maximum yearly contributions (an associated tax deduction) are determined as follows:

• For individuals, it is the lesser of:

a) $2,600 or
b) The plan's annual deductible

• For families, it is the lesser of:

a) $5,150 or
b) The plan's annual deductible

* Please note if you are between the ages of 55 and 65, you can make an additional catch-up contribution (up to $500 in 2004).

Ronald J. Kaley, MBA is a Tax Manager with Echelbarger, Himebaugh, Tamm & Co., P.C. (EHTC). He specializes in the areas of tax, business planning and cost segregation studies. He may be reached at 616.575.3482 or email ronk@ehtc.com.