Congress authorized health savings accounts (HSAs) in the Medicare Prescription
Drug, Improvement and Modernization Act of 2003. HSAs are a way to save for
medical expenses on a tax favored basis.
What Is an HSA?
In general, HSAs are modeled after Archer Medical Savings Accounts (not to be
confused with flexible spending accounts). Thus, an HSA is a trust or custodial
account created exclusively for the benefit of the account holder and is subject
to rules similar to those that apply to individual retirement arrangements
(IRAs). As discussed below, contributions to, and distributions from HSAs
receive favorable federal income tax treatment and the funds in an HSA are not
subject to federal income tax.
Who Is Eligible to Benefit Under HSAs?
HSAs are available to employees under age 65 covered under a certain type of
health plan. For an employee of an eligible employer to be eligible to make HSA
contributions (or have employer contributions made on his or her behalf), the
employee must be covered under an employer-sponsored "high deductible"
(see below) health plan and cannot be covered under any other health plan, other
than one providing certain permitted coverage.
In the case of an employee, contributions can be made to an HSA either by the
employee or by someone else on his or her behalf, including the employer.
Rollover contributions also may be made to an HSA from an Archer MSA. Unlike
Archer MSAs, HSA contributions may be made available as an option under a
cafeteria plan.
What Is a "High Deductible" Plan?
A "high deductible" plan is a health plan with an annual deductible
of at least $1,000 for individual coverage, or an annual deductible of at least
$2,000 for family coverage. Also, the maximum out-of-pocket expenses with
respect to allowed costs, including the deductible, cannot exceed $5,000 for
individual coverage and $10,000 for family coverage. These amounts are increased
annually for cost-of-living adjustments (COLAs).
How Are Contributions to an HSA Taxed?
Contributions by employees to an HSA are deductible, within limits,
"above the line," i.e., in computing adjusted gross income (AGI) for
federal income tax purposes. Employer contributions are excludible from
employees' gross income within the same limits. Earnings on amounts in an HSA
are not currently taxable, nor are distributions from an HSA that are used to
pay qualified medical expenses.
What Are the Limits on Deductibility of HSA Contributions?
The maximum annual contribution to an HSA for a year is the lesser of the
annual deductible under the high deductible health plan or $2,250 for individual
coverage, or $4,450 for family coverage. These amounts also are increased
annually for COLAs.
For individuals who have attained age 55 by the end of the taxable year, the
annual contribution limit is increased by $500 in 2004, $600 in 2005, $700 in
2006, $800 in 2007, $900 in 2008, and $1,000 in 2009 and thereafter.
All contributions to an Archer MSA and HSA are aggregated for purposes of the
maximum annual limit.
How Are Distributions from an HSA Taxed?
Distributions from an HSA to pay the medical expenses of the employee and his
or her spouse or dependents are excludible from income. Distributions that are
not used to pay medical expenses are subject to income tax. Such distributions
also are subject to an additional 10% penalty tax unless the distribution is
made after age 65 or on account of death or disability.
When may HSAs Be Established?
HSAs may be established for tax years beginning after December 31, 2003.
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