On February 4, 2016, Senator Orrin Hatch (R-Utah) and Congressman Erik Paulsen (R-Minn) introduced legislation entitled as the Health Savings Act of 2016.
This legislation is intended to simplify and expand health savings accounts (HSAs) and flexible spending accounts (FSAs).
This article intends to examine what effect this legislation will have on HSAs. Before looking at the proposed changes, let's have an overview of the HSA program.
1. Background on HSAs
On December 8, 2003, President George W. Bush signed into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (also known as the Medicare Modernization Act or "MMA") which was the legislation that created HSAs.
During the past twelve years HSAs have experienced explosive annual growth rates of 25 to 30 percent and are expected to have assets over thirty billion dollars with over 19.7 million Americans currently having accounts.
Although there was initial concern that the passage of the Patient Protection and Affordable Care Act might constrain the growth of HSAs that has not happened in the five years since the law's passage. HDHPs and HSAs are widely available both on and outside of health care exchanges.
An HSA is a tax-favored account that is used to pay for qualified medical expenses. HSA contributions are tax-deductible, or potentially pretax if made by an employer. It is always used in conjunction with a qualified HDHP.
The HSA is a custodial or trust account and therefore individuals must open an HSA with an IRS-approved custodian or trustee. Most HSAs today are based on checking accounts and the money is deposited at a bank, credit union or other HSA-approved custodian.
2. Pros and cons of an HSA
HSAs can be invested in stocks, bonds, mutual funds and a wide variety of other investment choices. HSA owners often use their HSA much as they would a checking account: writing checks, using a debit card or even withdrawing money from an ATM to pay for qualified medical expenses.
Advantages of an HSA:
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Tax-free distributions: HSA owners can use an HSA tax-free to pay for qualified medical expenses for themselves, their spouse/partner, and their dependents.
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Tax deductible individual contributions: HSA owners can deduct HSA contributions on their federal and, in most cases, their state income tax returns. HSA owners do not need to itemize to get the tax deduction and there are no income limits. There are HSA limits as to how much a person can contribute, but the limits are high compared to Flexible Spending Accounts (a common alternative to an HSA).
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Pre-tax employer contributions: Contributions made pre-tax by an employer (employer contributions or employee payroll deferral) are not included as taxable income on the HSA owner's IRS Form W-2. HSA owners avoid federal income taxes, Social Security taxes, Medicare taxes (together with Social Security referred to as FICA), Federal Unemployment Taxes (FUTA), Railroad Retirement Tax Act, and in most cases state income and State Unemployment Taxes (SUTA). Because employer contributions are never included in income, HSA owners cannot deduct them on their income tax return.
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Tax-free earnings: Any interest or other earnings grow tax-free in the HSA.
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Balance rolls over: HSA balances roll over from year to year if HSA owners do not spend the money. No "use it or lose it" as is sometimes true for other medical spending account plans.
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HSA remains after separation from service: An HSA remains with the HSA owner after separation from service even if the employer provided the HSA funding.
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Transferability: HSA owners can move their HSA to a new HSA custodian at any time.
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Ownership: HSA owners own the money in their HSA and can use it as they see fit. This relates to other benefits already mentioned, but also provides HSA owners the ability to name beneficiaries on the account, select investments, and decide when to take a distribution (even if the distribution is for a nonmedical reason).
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Control spending: An HSA gives HSA owners some additional control over their medical spending. The HSA owner can decide where to spend the money and can negotiate with providers when appropriate. This gives the HSA owner some freedom to choose medical providers outside of an insurance company's network or to try alternative approaches (within the definition of "qualified medical expense").
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Lower insurance premiums: HDHPs are generally less expensive than traditional insurance.
Potential disadvantages of an HSA and HDHP:
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More responsibility for health care spending: HSAs require individuals to take charge of their own health care spending. This will generally require more time devoted to learning about health care costs and alternatives than a person with traditional insurance coverage undertakes where much of the expense is simply paid.
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Tax reporting: HSA owners are required to account for both HSA contributions and distributions each year on their income tax return. In addition, the HSA owner needs to save medical receipts.
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HSA rules: HSAs, similar to all tax-driven types of accounts, can get complex. The HSA owner is responsible to learn the HSA rules and follow them or face tax consequences.
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HSA maintenance: The HSA owner is responsible to maintain the HSA — pay medical bills, monitor balances, choose beneficiaries, and otherwise maintain the HSA.
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Higher deductibles: An HSA owner faces a higher health insurance deductible than a person with traditional insurance and may need to pay that larger deductible amount. This can be an increased cost burden (although lower deductibles generally mean higher premiums, which also can be a burden).
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Expenses before savings: An HSA owner may face a large medical expense prior to having time to build a sufficient balance in the HSA.
3. Proposed changes of the 2016 Health Savings Act
The proposed legislation offers nearly two dozen changes to Health Savings Accounts, stating that it is addressing questions and concerns that have been raised since HSAs were created back in 2003 but have not been addressed.
In addition to the renaming of "High Deductible Health Plans" to "HSA-eligible health plan" there are significant proposed changes to how HSAs operate and what they cover. Specifically, these changes include the following: