Health Savings Act of 2016: Will it change HSAs?

March 28, 2016 at 10:41 AM

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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:

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.
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).
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.
Tax-free earnings: Any interest or other earnings grow tax-free in the HSA.
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.
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.
Transferability: HSA owners can move their HSA to a new HSA custodian at any time.
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).
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").
Lower insurance premiums: HDHPs are generally less expensive than traditional insurance.

Potential disadvantages of an HSA and HDHP:

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.

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.

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.

HSA maintenance: The HSA owner is responsible to maintain the HSA — pay medical bills, monitor balances, choose beneficiaries, and otherwise maintain the HSA.

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).

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:

Increased access to tax-preferred accounts

Eight sections (Sections 201 through Section 208) are geared toward making the Health Savings Accounts more accessible and attractive. These include the following enhancements.

Catch-up contributions: Section 201 would change the law by allowing an account owner's spouse who is an HSA account owner to make a catch-up contribution to a spouse's account — by allowing both spouses to make contributions to the same account, it is essentially doubling up the catch-up contribution.
Expanded access to Medicare recipients:
- Section 201 allows HSA-eligible seniors who are enrolled only in Part A of Medicare to continue to contribute to their Health Savings Accounts. The intent is to allow seniors to continue to utilize their HSAs to cover the deductible for hospital admissions which can be high — under Part A.
- In addition, Section 202 allows Medicare recipients participating in Medicare Advantage MSAs to contribute their own money to Medicare Medical Savings Accounts to cover the annual shortfall in coverage — something currently not permitted
Expanded access to veterans and Native Americans: Sections 203 and 204 propose that restrictions be removed from individuals utilizing either Indian Health Service Assistance or TRICARE coverage from contributing to their HSA. In addition the law proposes changes to allow members of health care sharing ministries to establish Health Savings Accounts.
On-site medical clinic coverage: Section 207 proposes adding subparagraph (f) to Section 223, creating a "Special Rule for Individuals Eligible for On-Site Medical Clinic Coverage." This change would ensure that a person would not be considered as covered under a health plan merely because there is an on-site medical clinic provided by the employer as long as it didn't provide "significant benefits."

Specifically excluded from classification as "significant" are physicals and immunizations, injecting antigens provided by employees, medications available without a prescription, such as pain relievers and antihistamines, treatment for injuries occurring at the employer's place of employment or otherwise in the course of employment, tests for infectious conditions such as streptococcal sore throat, monitoring of chronic conditions such as diabetes, drug testing, hearing or vision screenings and related services, and other similar treatments and services.

More favorable treatment of deductibles: Section 208 addresses family health plans with embedded deductibles, reducing restrictions which currently prevent individuals for becoming HSA-eligible.

Improving coverage for HSA accounts

Allowing distributions for over-the-counter medications: Section 301 proposes amending not only HSAs but Archer MSAs, FSAs, and Health Reimbursement Arrangements (HRAs) as well to allow coverage for both prescription AND over-the-counter medications and drugs. The bill also stipulates that reimbursement for expenses incurred for any prescription or over-the-counter medicine or drug shall be treated as a reimbursement for medical expenses.

Purchase of health insurance from HSA: Section 302 proposes amending the language in Section 152 by striking "and any dependent of such individual" in subparagraph A and inserting "any dependent of such individual, and any child of such individual who has not attained the age of 27 before the end of such individual's taxable year". The Bill also proposes striking subparagraph (B) and inserting the following: "Health insurance may not be purchased from account, except as provided in subparagraph (C), subparagraph (A) shall not apply to any payment for insurance".

Special rule for certain medical expenses incurred before establishment of account: Section 303 adds subparagraph (D) after Section 223(d)(2) allowing inclusion as qualified medical expenses for treatment of certain medical expenses incurred before the establishment of an account

Preventative care prescription drug clarification: Clarifies the use of drugs in preventative care by amending subparagraph (C) of section 223(c)(2) to add the following: "Preventative care shall include prescription and over-the-counter drugs and medicines which have the primary purpose of preventing the onset of, further deterioration from, or complications associated with chronic conditions, illnesses, or diseases."

Ensuring compliance with 'minimum value' mandate of PPACA:

"Minimum value" requirements: Section 401 specifically proposes modification of Section 36B of the Internal Revenue Code to ensure that HSA-eligible plans qualify as meeting the minimum value requirement

Other provisions:

Ease in enabling rollovers: Section 501 attempts to provide employers greater opportunity to roll over funds from employees FSAs or HRAs to their HSAs in a future year. Currently it is difficult to roll over FSA funds to an HSA unless a grace period is offered by the employer. In addition, currently the amount that can be rolled over to an HSA cannot exceed an amount in such an account as of September 21, 2006 – essentially preventing most employees from ever being able to roll fund from an FSA or HRA to their HSAs!
Bankruptcy Protections: Section 502 amends current law by allowing HSAs to be treated in the same manner as an individual retirement account, thus extending the same bankruptcy protections as received by retirement plans.
Avoidance of the "Cadillac Tax": Section 503 attempts to ensure that individuals are not subject to Cadillac Tax penalties for administrative errors. Kevin McKetchie of the ABA Banking Journal welcomed the possibility that the modifications would exempt HSAs from the Cadillac tax, as well as streamline their administration and make them more available to more individuals.
Medicaid Health Opportunity Accounts: Section 504 amends the existing law to reauthorize health opportunity accounts in Medicaid as a demonstration program. This section also allows for health opportunity accounts to be maintained for 3 years after a person becomes ineligible for Medicaid benefits so that they have access to those funds for their health care.
Exercise equipment/fitness programs: Amends the current definition of "medical care" to include equipment for physical exercise or health coaching.
- This includes equipment for use in a exercise or fitness program (including self-directed).
- Instruction in physical exercise, nutrition or health coaching (including self-directed):This is limited to $1,000 for any individual during a calendar year. In addition, certain restrictions are spelled out regarding what qualifies as a fitness facility requiring it to be a facility that provides exercise and fitness programs and is not a private club and does not offer golfing, hunting, sailing or riding facilities.
Certain nutritional and dietary supplements to be treated as Medical Care: Amends the current definition of "medical care" to include dietary and nutritional supplements. This would expand the definition of "medical care" to the purchase of herbs, vitamins, minerals, homeopathic remedies, meal replacement products, and other dietary and nutritional supplements. Purchases of these products would be limited to $1,000 for any individual in a calendar year. In the situation with "Meal Replacement Products", the proposed section includes products meeting the requirements of section 403(r)(3) of the Federal Food, Drug and Cosmetic Act and is permitted to claim that the product is low in fat and a good source of protein, fiber and essential vitamins and minerals.

This section in particular, has generated a great deal of media interest. The Natural Products Association has sent more than a thousand letters to Congress urging support of this proposed change – calling it a "commonsense move to help consumers live a healthier and more balanced lives" In the letter to Congress, Daniel Fabricant, Ph.D., and Executive Director and CEO of the NPA stated "Although more than half of Americans use supplements regularly, "organized health care plans" do not support the products."

Certain provider fees to be treated as medical care: Amends the current definition of "medical care" to include periodic fees paid for specific medical services or the right to receive medical services on an as-needed basis. Health FSAs are not considered insurance.

At this point in time, the bill is before Congress as H.R. 4469 "Health Savings Act of 2016" and has been assigned to Committee and in the Senate as Senate Bill S. 2449. Other than referral to various committees, no action has yet been taken.

Overall, these proposed changes have been met positively by the industry. A great deal of support is being mustered by the Natural Products Industry including the American Herbal Products Associations, the Consumer Health care Products Association, the Council for Responsible Nutrition, the Natural Products Association, and the United Natural Products Alliance.

In addition, the ERISA Industry Committee (ERIC) has issued a letter supporting the legislation, especially in regard to exempting HSAs from the Cadillac Tax. In addition the American Banking Association has strongly supported the bill as well.

Will it pass? Only time will tell. If the past is an indicator, the likelihood is not particularly good as this legislation was introduced last year and a few times before that as well.

However, there does seem to be more publicity and support this time around.

See also:

9 FAQs about HSAs, FSAs and HRAs

7 ways to make your clients' portfolios tax efficient

The HSA engagement alphabet

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