Health Savings Accounts – An American Innovation in Health Insurance
The term “health insurance” is commonly used in the United States to describe any program that helps pay for medical expenses, weather through privately purchased insurance, social insurance, or a non-insurance social welfare program funded by the government. Synonyms for this usage include “health coverage,” “health care coverage,” and “health benefits,” and “medical insurance.” In a more technical sense, the term is used to describe any form of insurance that protects against injury or illness.
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In America, the health insurance industry has changed rapidly during the last few decades. In the 1970’s most people who had health insurance had indemnity insurance. Indemnity insurance is often called fee-for-service. The traditional health insurance in which the medical provider (usually a doctor or hospital) is paid a fee for each service provided to the patient covered under the policy. An important category associated with indemnity plans is that of consumer-driven health care (CDHC). Consumer-directed health plans allow individuals and families to have greater control over their health care, including when and how they access care, what types of care they receive, and how much they spend on health care services.
However, these plans are associated with higher deductibles that the insured has to pay from their pocket before claiming insurance money. Consumer-driven health care plans include Health Reimbursement Plans (HRAs), Flexible Spending Accounts (FSAs), high deductible health plans (HDHps), Archer Medical Savings Accounts (MSAs), and Health Savings Accounts (HSAs). Of these, the Health Savings Accounts are the most recent, and they have witnessed rapid growth during the last decade.
WHAT IS A HEALTH SAVINGS ACCOUNT?
A Health Savings Account (HSA) is tax-advantaged medical savings account available to taxpayers in the United States. The funds contributed to the account are not subject to federal income tax at the time of deposit. These may be used to pay for qualified medical expenses at any time without federal tax liability.
Another feature is that the funds contributed to the Health Savings Account roll over and accumulated year over year if not spent. The employees can withdraw these at the time of retirement without any tax liabilities. Withdrawals for qualified expenses and interest earned are also not subject to federal income taxes. Consider speaking with a TurboTax Live tax expert online from the comfort of your Dallas home if you need help. According to the U.S. Treasury Office, ‘A Health Savings Account is an alternative to traditional health insurance; it is a savings product that offers a different way for consumers to pay for their health care.
HSA’s enable you to pay for current health expenses and save for future qualified medical and retiree health expenses on a tax-free basis.’ Thus, the Health Savings Account is an effort to increase the American health care system’s efficiency and encourage people to be more responsible and prudent towards their health care needs. It falls in the category of consumer-driven health care plans.
Origin of Health Savings Account
The Health Savings Account was established under the Medicare Prescription Drug, Improvement, and Modernization Act passed by the U.S. Congress in June 2003, by the Senate in July 2003, and signed by President Bush on December 8, 2003.
The following individuals are eligible to open a Health Savings Account –
– Those who are covered by a High Deductible Health Plan (HDHP).
– Those not covered by other health insurance plans.
– Those not enrolled in Medicare4.
Also, there are no income limits on who may contribute to a HAS, and there is no requirement of having earned income to contribute to a HAS. However, HAS’s can’t be set up by those dependent on someone else’s tax return. Also, HSA’s cannot be set up independently by children.
What is a High Deductible Health Plan (HDHP)?
Enrollment in a High Deductible Health Plan (HDHP) is necessary for anyone wishing to open a Health Savings Account. In fact, the HDHPs got a boost by the Medicare Modernization Act, which introduced the HSAs. A High Deductible Health Plan is a health insurance plan which has a certain deductible threshold. This limit must be crossed before the insured person can claim insurance money. It does not cover first dollar medical expenses. So an individual has to himself pay the initial expenses that are called out-of-pocket costs.
In several HDHPs, immunization and preventive health care costs are excluded from the deductible, which means that the individual is reimbursed for them. HDHPs can be taken both by individuals (self-employed as well as employed) and employers. In 2008, HDHPs were being offered by insurance companies in America with deductibles ranging from a minimum of $1,100 for Self and $2,200 for Self and Family coverage. The maximum amount out-of-pocket limits for HDHPs is $5,600 for self and $11,200 for Self and Family enrollment.
These deductible limits are called IRS limits set by the Internal Revenue Service (IRS). In HDHPs, the relation between the deductibles and the insured’s premium is inversely proportional, i.e., higher the deductible, lower the premium, and vice versa. The major purported advantages of HDHPs are that they will a) lower health care costs by causing patients to be more cost-conscious and b) make insurance premiums more affordable for the uninsured. The logic is that when the patients are fully covered (i.e., have health plans with low deductibles), they tend to be less health-conscious and also less cost conscious when going for treatment.
Opening a Health Savings Account
An individual can sign up for HSAs with banks, credit unions, insurance companies, and other approved companies. However, not all insurance companies offer HSAqualified health insurance plans, so it is important to use an insurance company that offers this type of qualified insurance plan. The employer may also set up a plan for the employees. However, the account is always owned by the individual. Direct online enrollment in HSA-qualified health insurance is available in all states except Hawaii, Massachusetts, Minnesota, New Jersey, New York, Rhode Island, Vermont, and Washington.
Contributions to the Health Savings Account
Contributions to HSAs can be made by an individual who owns the account, by an employer, or by any other person. When made by the employer, the contribution is not included in the income of the employee. When made by an employee, it is treated as exempted from federal tax. For 2008, the maximum amount that can be contributed (and deducted) to an HSA from all sources is:
$2,900 (self-only coverage)
$5,800 (family coverage)
The U.S. Congress sets these limits through statutes, and they are indexed annually for inflation. There is a special catch-up provision for individuals above 55 years of age that allows them to deposit an additional $800 for 2008 and $900 for 2009. The actual maximum amount an individual can contribute also depends on the number of months he is covered by an HDHP (pro-rated basis) as of the first day of a month. E.g., If you have family HDHP coverage from January 1, 2008, until June 30, 2008, then cease having HDHP coverage, you are allowed an HSA contribution of 6/12 of $5,800, or $2,900 for 2008.
If you have family HDHP coverage from January 1, 2008, until June 30, 2008, and have self-only HDHP coverage from July 1, 2008, to December 31, 2008, you are allowed an HSA contribution of 6/12 x $5,800 plus 6/12 of $2,900, or $4,350 for 2008. If an individual opens an HDHP on the first day of a month, then he can contribute to HSA on the first day itself. However, if he/she opens an account on any other day than the first, he can contribute to the HSA from the next month. Contributions can be made as late as April 15 of the following year. Contributions to the HSA over the contribution limits must be withdrawn by the individual or be subject to an excise tax. The individual must pay income tax on the excess withdrawn amount.
Contributions by the Employer
The employer can contribute to the employee’s HAS account under a salary reduction plan known as the Section 125 plan. It is also called a cafeteria plan. The contributions made under the cafeteria plan are made on a pre-tax basis, i.e., they are excluded from the employee’s income. The employer must contribute on a comparable basis. Comparable contributions are contributions to all HSAs of an employer, which is 1) the same amount or 2) the same percentage of the annual deductible. However, part-time employees who work for less than 30 hours a week can be treated separately. The employer can also categorize employees into those who opt for self coverage only and those who opt for family coverage. The employer can automatically make contributions to the HSAs on behalf of the employee unless the employee specifically chooses not to have such contributions by the employer.
Withdrawals from the HSAs
The employee owns the HSA, and he/she can make qualified expenses from it whenever required. He/She also decides how much to contribute to it, how much to withdraw for qualified expenses, which company will hold the account, and what type of investments will grow the account. Another feature is that the funds remain in the account and roll over from year to year. There is no use it or lose it rules. The HSA participants do not have to obtain advance approval from their HSA trustee or their medical insurer to withdraw funds. The funds are not subject to income taxation if made for ‘qualified medical expenses.
Qualified medical expenses include costs for services and items covered by the health plan but subject to cost-sharing such as a deductible and coinsurance, or co-payments, as well as many other expenses not covered under medical plans, such as dental, vision, and chiropractic care; durable medical equipment such as eyeglasses and hearing aids; and transportation expenses related to medical care. Nonprescription, over-the-counter medications are also eligible. However, qualified medical expenses must be incurred on or after the HSA was established.
Tax-free distributions can be taken from the HSA for the qualified medical expenses of the person covered by the HDHP, the spouse (even if not covered) of the individual, and any dependent (even if not covered) individual.12 The HSA account can also be used to pay the previous year’s qualified expenses subject to the condition that those expenses were incurred after the HSA was set up.
The individual must preserve the receipts for expenses met from the HSA as they may be needed to prove that the withdrawals from the HSA were made for qualified medical expenses and not otherwise used. Also, the individual may have to produce the receipts before the insurance company proves that the deductible limit was met. If a withdrawal is made for unqualified medical expenses, then the amount withdrawn is considered taxable (it is added to the individual’s income) and is also subject to an additional 10 percent penalty. Normally the money also cannot be used for paying medical insurance premiums. However, in certain circumstances, exceptions are allowed.
These are –
1) to pay for any health plan coverage while receiving federal or state unemployment benefits.
2) COBRA continuation coverage after leaving employment with a company that offers health insurance coverage.
3) Qualified long-term care insurance.
4) Medicare premiums and out-of-pocket expenses, including deductibles, co-pays, and coinsurance for Part A (hospital and inpatient services), Part B (physician and outpatient services), Part C (Medicare HMO and PPO plans), and Part D (prescription drugs).
However, if an individual dies, becomes disabled, or reaches the age of 65. Withdrawals from the Health Savings Account are considered exempted from income tax and an additional 10 percent penalty irrespective of the purpose for which those withdrawals are made. There are different methods through which funds can be withdrawn from the HSAs. Some HSAs provide account holders with debit cards, some with cheques, and some have options for a reimbursement process similar to medical insurance.
Growth of HSAs
Ever since the Health Savings Accounts came into being in January 2004, there has been a phenomenal growth in their numbers. From around 1 million enrollees in March 2005, the number has grown to 6.1 million enrollees in January 2008.14 This represents an increase of 1.6 million since January 2007, 2.9 million since January 2006, and 5.1 million since March 2005. This growth has been visible across all segments. However, the growth in large groups and small groups has been much higher than in the individual category. According to the projections made by the U.S. Treasury Department, the number of HSA policy holders will increase to 14 million by 2010. These 14 million policies will provide cover to 25 to 30 million U.S. citizens.
In the Individual Market, 1.5 million people were covered by HSA/HDHPs purchased in January 2008. Based on the number of covered lives, 27 percent of newly purchased individual policies (defined as those purchased during the most recent full month or quarter) were enrolled in HSA/HDHP coverage. In the small group market, enrollment stood at 1.8 million as of January 2008. In this group, 31 percent of all new enrollments were in the HSA/HDHP category. The large group category had the largest enrollment, with 2.8 million enrollees as of January 2008. In this category, six percent of all new enrollments were in the HSA/HDHP category.
Benefits of HSAs
The proponents of HSAs envisage several benefits from them. First and foremost, it is believed that as they have a high deductible threshold, the insured will be more health-conscious. Also, they will be more cost-conscious. The high deductibles will encourage people to be more careful about their health and health care expenses and make them shop for bargains, and be more vigilant against excesses in the health care industry. This, it is believed, will reduce the growing cost of health care and increase the healthcare system’s efficiency in the United States. HSA-eligible plans typically provide enrollee decision support tools that include, to some extent, information on the cost of health care services and the quality of health care providers.
Experts suggest that reliable information about the cost of particular health care services and the quality of specific health care providers would help enrollees become more actively engaged in making health care purchasing decisions. These tools may be provided by health insurance carriers to all health insurance plan enrollees but are likely to be more important to HSA-eligible plans who have a greater financial incentive to make informed decisions about the quality and costs of health care providers and services.
It is believed that lower premiums associated with HSAs/HDHPs will enable more people to enroll in medical insurance. This will mean that lower-income groups who do not have access to medicare will open HSAs. No doubt, higher deductibles are associated with HSA eligible HDHPs. Still, it is estimated that tax savings under HSAs and lower premiums will make them less expensive than other insurance plans. The funds put in the HSA can be rolled over from year to year. There is no use it or lose it rules. This leads to a growth in the savings of the account holder. The funds can be accumulated tax-free for future medical expenses if the holder so desires. Also, the savings in the HSA can be grown through investments.
The nature of such investments is decided by the insured. The earnings on savings in the HSA are also exempt from income tax. The holder can withdraw his savings in the HSA after turning 65 years old without paying any taxes or penalties. The account holder has complete control over his/her account. He/She is the owner of the account right from its inception. A person can withdraw money as and when required without any gatekeeper. Also, the owner decides how much to put in his/her account, how much to spend and how much to save for the future. The HSAs are portable in nature. This means that if the holder changes his/her job, becomes unemployed, or moves to another location, he/she can still retain the account.
If the account holder so desires, he can transfer his Health Saving Account from one managing agency to another. Thus portability is an advantage of HSAs. Another advantage is that most HSA plans provide first-dollar coverage for preventive care. This is true of virtually all HSA plans offered by large employers and over 95% of small employers’ plans. It was also true of over half (59%) of the plans which individuals purchased.
All of the plans offering first-dollar preventive care benefits included annual physicals, immunizations, well-baby, well-child care, mammograms, and Pap tests; 90% included prostate cancer screenings, and 80% included colon cancer screenings. Some analysts believe that HSAs are more beneficial for the young and healthy as they do not have to pay frequent out-of-pocket costs. On the other hand, they have to pay lower premiums for HDHPs, which help them meet unforeseen contingencies.
Health Savings Accounts are also advantageous for employers. The benefits of choosing a health Savings Account over a traditional health insurance plan can directly affect the bottom line of an employer’s benefit budget. For instance, Health Savings Accounts are dependent on a high deductible insurance policy, which lowers the employee’s plan’s premiums. All contributions to the Health Savings Account are pre-tax, thus lowering the gross payroll and reducing the amount of taxes the employer must pay.
Criticism of HSAs
Health Savings Accounts’ opponents contend that they would do more harm than good to America’s health insurance system. Some consumer organizations, such as the Consumers Union, and many medical organizations, such as the American Public Health Association, have rejected HSAs because, in their opinion, they benefit only healthy, younger people and make the health care system more expensive for everyone else. According to Stanford economist Victor Fuchs, “The main effect of putting more of it on the consumer is to reduce the social redistributive element of insurance.
Some others believe that HSAs remove healthy people from the insurance pool, making premiums rise for everyone left. HSAs encourage people to look out for themselves more and spread the risk around less. Another concern is that the money people save in HSAs will be inadequate. Some people believe that HSAs do not allow for enough savings to cover costs. Even the person who contributes the maximum and never takes any money out will not cover health care costs in retirement if inflation continues in the health care industry.
Opponents of HSAs, also include distinguished figures like state Insurance Commissioner John Garamendi, who called them a “dangerous prescription” that will destabilize the health insurance marketplace and make things even worse for the uninsured. Another criticism is that they benefit the rich more than the poor. Those who earn more will be able to get bigger tax breaks than those who earn less. Critics point out that higher deductibles and insurance premiums will take away a large share of the low-income groups’ earnings. Also, lower-income groups will not benefit substantially from tax breaks as they are already paying little or no taxes. On the other hand, tax breaks on savings in HSAs and on further income from those HSA savings will cost billions of dollars of tax money to the exchequer.
The Treasury Department has estimated HSAs would cost the government $156 billion over a decade. Critics say that this could rise substantially. Several surveys have been conducted regarding the efficacy of the HSAs. Some have found that the account holders are not particularly satisfied with the HSA scheme, and many are even ignorant about the working of the HSAs. One such survey conducted in 2007 of American employees by the human resources consulting firm Towers Perrin showed satisfaction with account-based health plans (ABHPs) was low. People were not happy with them in general compared with people with more traditional health care. Respondents said they were not comfortable with the risk and did not understand how it works.
According to the Commonwealth Fund, early experience with HAS-eligible high-deductible health plans reveals low satisfaction, high out of- pocket costs, and cost-related access problems. Another survey conducted with the Employee Benefits Research Institute found that people enrolled in HSA-eligible high-deductible health plans were much less satisfied with many aspects of their health care than adults in more comprehensive plans. People in these plans allocate substantial amounts of income to their health care, especially those with poorer health or lower incomes. The survey also found that adults in high-deductible health plans are far more likely to delay or avoid getting needed care or to skip medications because of the cost. Problems are particularly pronounced among those with poorer health or lower incomes.
Political leaders have also been vocal about their criticism of the HSAs. Congressman John Conyers, Jr. issued the following statement criticizing the HSAs “The President’s health care plan is not about covering the uninsured, making health insurance affordable, or even driving down the cost of health care. Its real purpose is to make it easier for businesses to dump their health insurance burden onto workers, give tax breaks to the wealthy, and boost banks and financial brokers’ profits. The health care policies concocted at the behest of special interests do nothing to help the average American. In many cases, they can make health care even more inaccessible.” In fact, a report of the U.S. Government Accountability Office, published on April 1, 2008, says that the rate of enrollment in the HSAs is greater for higher-income individuals than for lower-income ones.
A study titled “Health Savings Accounts and High Deductible Health Plans: Are They an Option for Low-Income Families? Catherine Hoffman and Jennifer Tolbert, which the Kaiser Family Foundation sponsored, reported the following key findings regarding the HSAs:
a) Premiums for HSA-qualified health plans may be lower than traditional insurance, but these plans shift more financial risk to individuals and families through higher deductibles.
b) Premiums and out-of-pocket costs for HSA-qualified health plans would consume a substantial portion of a low-income family’s budget.
c) Most low-income individuals and families do not face high enough tax liability to benefit in a significant way from tax deductions associated with HSAs.
d) People with chronic conditions, disabilities, and others with high-cost medical needs may face even greater out-of-pocket costs under HSA-qualified health plans.
e) Cost-sharing reduces the use of health care, especially primary and preventive services, and low-income individuals and those who are sicker are susceptible to cost-sharing increases.
f) Health savings accounts and high deductible plans are unlikely to increase healthcare coverage among the uninsured substantially.
Choosing a Health Plan
Despite the advantages offered by the HSA, it may not be suitable for everyone. While choosing an insurance plan, an individual must consider the following factors:
1. The premiums to be paid.
2. Coverage/benefits available under the scheme.
3. Various exclusions and limitations.
5. Out-of-pocket costs like coinsurance, co-pays, and deductibles.
6. Access to doctors, hospitals, and other providers.
7. How much and sometimes how one pays for care.
8. Any existing health issue or physical disability.
9. Type of tax savings available.
The plan you choose should be according to your requirements and financial ability.