The Patient Protection and Affordable Care Act, which was signed into law a year ago, contains 10 titles and 26 subtitles. The Health Care and Education Reconciliation Act soon amended that law with two titles and eight subtitles. Amid the thousands of pages in these health-care acts, only two minor provisions directly affect health savings accounts (HSAs).
Nevertheless, HSAs seemed to have benefited from this benign neglect. "HSAs have gained in popularity since the passage of healthcare legislation last March," says Terry McCorvie, CEO of Workable Solutions, a benefits administration firm in Orlando, Fla. HSAs are still growing, although assets are still modest, and advisors, consumers and employers remain interested. Moreover, integral parts of last year's healthcare reform law may actually encourage the growth of HSAs.
HSAs are available to individuals covered by specific types of high-deductible (and thus low-premium) health insurance. Eligible clients and participating employers can make tax-deductible contributions to HSAs, in which any investment growth is untaxed. HSA withdrawals are also tax-free as long as the money is spent on qualified medical costs. "It's the only triple tax-advantaged plan out there," says Paul Fronstin, director of the Health Research & Education Program at the Employee Benefit Research Institute (EBRI) in Washington.
An EBRI survey found that there was $7.7 billion in HSAs and health reimbursement arrangements (HRAs) in 2010, spread across 5.7 million accounts. (HRAs are employer-provided plans with some similarities to HSAs.) In 2006, there were 1.2 million of these accounts with $835.4 million in assets; in 2009, five million accounts held $7.1 billion in assets. While total assets in these accounts have increased each year, average account balances have remained small, ranging between $1,320 and $1,419 since 2007.
Another 2010 survey, from America's Health Insurance Plans (AHIP), found that about 10 million people were covered by what the association calls "HSA/high-deductible health plans," an increase of 25% from 2009. Large group coverage led the way, growing by 33%.
Not everyone who is covered by a qualifying high-deductible health insurance policy opens an HSA, though. EBRI has reported that 37% of the people eligible for an HSA did not have one. The primary reasons were not having money to fund the account and not seeing the need for one.
"Lower-income people might not get much tax benefit from an HSA," Fronstin says. "For upper-income people, low participation probably results from a combination of laziness and lack of knowledge. Planners can play a huge role in explaining HSAs to their clients."
HSA explanations now should include those two provisions of the new health- care laws that impact these accounts directly. For instance, HSA withdrawals used for non-qualifying expenses before age 65 will be hit with a 20% fine, in addition to ordinary income tax. Under prior law, the penalty was 10%.
In addition, the cost of over-the-counter (OTC) medicines can't be reimbursed with excludable income through HSAs unless a prescription is obtained, says Marty James, who heads an accounting and investment advisory firm in Mooresville, Ind. Under prior law, HSA owners could easily tap their accounts to use pretax dollars for many types of readily available health remedies. Now an HSA owner must get a prescription to justify tax-free HSA withdrawals for these purchases.
One strategy is to ask a physician to write prescriptions for a year's worth of OTC medications. An HSA owner who then buys the OTC medications and keeps receipts as well as the prescriptions can tap the account for those purchases.
"The way the law is written and being administered by the IRS, if you have a prescription the OTC medication qualifies as an eligible HSA expense," James says. "But if the government eventually determines that there is abuse in this area, they probably will modify this provision." For now, McCorvie says, the IRS allows use of payment cards to purchase OTC medications prescribed by a physician, as long as they are dispensed through a pharmacy.
Of course, asking a physician to write prescriptions for a year's worth of OTC medications may be controversial. Gary Midla, a family practitioner in Mooresville, says that the hospital with which he's affiliated sent out a notice last year urging doctors to help patients comply with the new rules. "If I'm treating a patient for arthritis, for example, and I think taking ibuprofen will help, I don't mind writing that as a prescription," he says.
A patient who comes in with a long list of OTC medications and requests prescriptions for a year's worth of each one will get a different response. "That's too time-consuming," Midla says, adding that he already has been approached by patients more than a dozen times for OTC prescriptions to satisfy HSA requirements; he has complied with some but rejected others, depending on the circumstances.
Other parts of last year's healthcare law may encourage the use of HSAs. By 2014, for example, most people will be required to have health insurance (assuming no change in the law before then). At the same time, businesses with 50 or more full-time employees will have to offer health insurance plans.
Assuming those individuals and companies want to spend as little as possible, they might opt for high-deductible plans, with their low premiums. "High-deductible plans coupled with HSAs are going to be the most affordable plans that meet the requirements for minimum essential coverage," McCorvie says.
For small businesses, HSA-compatible high-deductible plans are now the plan of choice, according to McCorvie. "They have gone that route because of affordability," he says. "In the small group market, a high-deductible plan is often the only plan being offered. Some employers contribute to the HSA, but many don't."
As more firms offer high-deductible health insurance and the chance to open an HSA, two types of HSA owners may emerge. The first is individuals who seek out such coverage, either because they're self-employed or have no employer-provided health plan. "They may have done some research into HSAs," says Linda Robertson, senior financial planner at Financial Finesse in El Segundo, Calif. "They might be more familiar with the advantages of these accounts."
On the other hand, employees who are offered a high-deductible plan paired with an HSA may be less knowledgeable. "They might have had flexible spending accounts (FSAs)," Robertson says. "If so, it has been drilled into them that FSAs are use-it-or-lose it." They might contribute only as much to the HSA as they intend to spend on healthcare in the short term.
In such situations, planners can advise clients that HSAs have no time limits on use, which makes long-term accumulation possible. Robertson tells of sitting down with a woman in her late thirties who wanted to increase her retirement savings. "She was thinking of reducing her HSA contribution so that she could put more into her 401(k)," Robertson says. "She wanted to cut her HSA contribution to $1,800, which would match the $1,800 deductible on her health insurance." Thus, this employee's HSA contribution would cover her out-of-pocket exposure.
In 2011, the maximum HSA contribution for someone under age 55 with single coverage is $3,050. (With family coverage the limit is $6,150, while people 55 and older can contribute an extra $1,000 with either type of coverage.) So Robertson suggested that the client contribute the maximum $3,050 and count the extra $1,250-the excess over her $1,800 health insurance deductible-as a supplement to her retirement savings.
This strategy puts money into an HSA, which permits tax-free withdrawals for healthcare, rather than into a 401(k), from which all withdrawals will be taxed. "As people get older, they are likely to have more medical expenses, so it would be beneficial to be able to pay for them with pretax dollars," Robertson says,
THE SWEET SPOT
HSA contribution limits may affect the type of health insurance that consumers choose, according to Keith Mendonsa, a consumer health insurance expert with eHealthInsurance in Mountain View, Calif. To qualify for an HSA, for example, family coverage this year must have a deductible of at least $2,400. The policy must limit out-of-pocket expenses (deductibles, copays, co-insurance, etc.) to no more than $11,900.
Most people don't want to risk nearly $12,000 a year, Mendonsa says, so they choose a deductible that's between the minimum deductible and the out-of-pocket maximum, perhaps $6,000 or $7,000 a year for family coverage.
With single coverage, a deductible midway between the $1,200 minimum and the $5,950 maximum out-of-pocket is a common choice, Mendonsa explains. Such deductibles might deliver reasonable premiums for health insurance along with out-of-pocket exposure that can be covered with pretax HSA contributions.
Many planners believe that higher tax rates will prevail in the future, a belief that has propelled a surge in Roth IRA conversions. The same reasoning would lead to maximizing HSA contributions each year, building up a substantial fund that eventually can pay for healthcare with already-taxed dollars.