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GUEST ARTICLE
Health Savings Accounts
July 2006

Health Savings Accounts
A Real Solution or the Newest Fad

By T. S. Herbert, VII

You may have heard in the news recently about a new option in the ongoing effort to reduce health care costs – Health Savings Accounts (HSA). HSAs have been around since 1996 but under a different name, Medical Savings Accounts. In 2003, Congress updated and simplified the concept giving us the modern Health Savings Account. So while the concept is not new, President Bush, the insurance industry, and others have been trying to raise public awareness about HSAs as one method to control ever increasing health care costs.

So what is an HSA and how does it actually work? In the simplest terms, you buy a low cost high deductible health insurance plan and you can put money away tax free in a savings account. But to better understand it, we will need to break the concept down into its two component parts. The first involves mandatory enrollment in a low-cost high deductible health Plan (HDHP). The second is the actual Health Savings Account where money can be put aside tax free.

Let’s begin with the health insurance plan. In order to qualify for the HSA and be able to put money away tax free, you must first purchase what the IRS defines as a qualified High Deductible Health Plan (HDHP). This is a policy with a minimum deductible of $1,050 for a single person or $2,100 for those with a dependent such as spouse, child, children and or family on the policy. These amounts are indexed to inflation and the IRS may increase these deductibles. All medical expenses including office visits, facility charges, and prescription drugs apply to this deductible. There is one exception, defined by and applied at the sole discretion of individual insurance companies, wellness visits can be covered not subject to the deductible but covered first dollar. Wellness visits could include routine physicals, yearly OBGYN checkups, or well child care, including immunizations. Other than the deductible limits, the government allows the insurance companies a lot of leeway with respect to plan design, but the IRS mandates that all expenses apply to the deductible, except for wellness care. For the most part insurance companies have kept it simple with the plan design. You have a choice of deductibles and coinsurance, and a pre-determined out of pocket limit. Again, the government sets the out of pocket limits (which includes deductible, coinsurance and copays) at $5,250 for single and $10,500 for family coverage. These figures are also indexed annually for inflation. Typical plans have coinsurance of 20% after the deductible, but there are some plans with higher a deductible paying 100% coinsurance. The premium for a HDHP can be tax deductible as well.

Most plans include a Preferred Provider Network, which typically is very large. You will want to choose doctors and providers participating in the network so you can benefit from the HDHP’s previously negotiated discounts. These discounts can be considerable, particularly for facility related charges. For example, you have not yet met your annual deductible and your son goes to the Emergency Room at the local hospital. The hospital charges $1,500 for services rendered. The invoice is sent to the insurance company where the $1,500 in charges for services could be reduced down to around $600 as a result of the negotiated discounts. At this point, your payment responsibility would be $600 rather than the original $1,500, assuming the hospital is a participating provider. Another example would be prescription drugs. When you go to the pharmacy, instead of having a fixed copay for a generic prescription that may list at $30, you would pay the discounted price, which may be around $18.

Once you are enrolled in a HDHP, the IRS then allows you to establish a Health Savings Account at a bank or other qualified financial institution. You are allowed to fund this account up to the lesser of either the deductible or an IRS maximum of $2,700 for singles or $5,450 per family. There is one limitation to contributions in the first year, you can only fund the deductible on a pro-rated basis. For example, your plan has a $1200 deductible and you enrolled July 1st. You can only make a contribution of $100 ($1,200 /12=$100) per the month for 6 months remaining in the year or a maximum contribution of $600 in the first year. Or if you establish a plan on January 1st and cancel coverage August 31st, you could only put in $800 because you were only in the plan for eight months. Contributions can either be written off at the end of the year or they can be made pre-tax. Contributions written off at year’s end would be handled as an itemized expense. In the case of pre-tax contributions, if you are working for a firm that offers an HSA option, you can direct contributions out of your paycheck before federal tax, FICA and state taxes are deducted. Additionally, employers would not be required to make the matching FICA match on any money contributed to the HSA.

As for funding the HSA, there is great flexibility. One option is to make monthly contributions. Let’s say you purchase a health plan which has a $2,700 deductible and pays 100% of expenses after the deductible is met. The plan becomes effective January 1st and you wish to fully fund the yearly deductible. You would then send monthly payments of $225( $2,700/12) to fully fund the HSA. As a second option, if you already have the cash on hand, you could initially deposit the full $2,700 up front. If cash flow is an issue then you can fund the HSA as you have the money available to the policy limits. The IRS even allows contributions to be made up to April 15th for the preceding year just like an IRA. So, using the above example of a $2,700 deductible, if you fund the deductible at $150 per month, at the end of the year you would have set aside $1,800. When it came time to file your taxes, you could deposit an additional $900 to fully fund the deductible to the $2,700 limit. Remember, the premium you pay for a HDHP is considerably less than a traditional health plan. In some cases, the savings in premium alone can be used to fund the HSA! Also, employers, as possibly part of a benefits package, can fund your HSA as well.

What makes the HSA so special? First, any money left in the account at the end of the year automatically rolls over to the next year. There are no limits on the amount of money that can roll forward as long as you follow the contribution rules outlined earlier. Second, the money in the account can be used to cover medical services not typically covered by your insurance policy such as eye glasses, lasic surgery, dental, even over the counter medications and bandages. However, you will need to remember these expenses do not apply towards meeting the plan’s deductible. Third, if you later find yourself at a company that does not have an HSA, you can still use the money that you have previously put aside in the HSA to pay office copays, deductibles and coinsurance. Fourth, you can use money in your HSA to cover medical expenses of a spouse or child that is not covered by the HSA. And finally, at age 65 when you are no longer eligible to fund the HSA because you are no longer eligible for the HDHP, you can use the money you already put in the HSA to purchase a qualified Long Term Care policy or pay for the Medicare out of pocket fees. Moreover, you still have the option to take the money as cash at retirement. You will then be responsible for paying taxes on the money taken as income, just like an IRA. Should you need the money prior to retirement and it is not for qualified medical expenses, you will be subject to taxes in addition to a 10% penalty.

In summation, HSA is a long-term solution to the escalating cost of health care. It reduces the amount of money that is sent off to the insurance company since you pay lower insurance premiums and it puts you in control of your medical care costs. Even with traditional plans, office copays and out of pockets are continuing to creep up. HSAs offer you a mechanism to help plan for your future. You can put money aside now and prepare for a time when you will need the insurance money, as opposed to paying higher premiums now for services you may not use. This ability to put money away pre-tax cannot be overemphasized. When you add the tax break to the discounts that the insurance company has already negotiated on your behalf, you are likely to see your real out of pocket go down due to these factors.
All things considered, HSAs appear to offer a viable option to controlling health care costs. Contacting your insurance professional about applicability based on your particular circumstances may well be worth the call. ##

About the Author

Thomas S. Herbert, VII, a principal at the Herbert Insurance Agency in Ashland, VA, specializes in employee benefits and health insurance. Mr. Herbert and his father, who has 35 years experience in employee benefits, established the agency in 1990, representing all of the managed care providers in the region. Today the agency continues to focus on employee benefits and individual health insurance needs and concepts. As an insurance professional, Mr. Herbert holds a Life Underwriter’s Training Council Fellow (LUTCF) designation and is currently working towards his Certified Insurance Counselors (CIC) and Certified Employee Benefit Specialist (CEBS) designations. He received his B.A. degree in Economics from the University of Maryland in 1988. His professional affiliations include membership in the Central Virginia Health Underwriters. Mr. Herbert can be reached at 804.798.4438, or via email at ashover@verizon.net.


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