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health savings accounts after their first 3 months

by Tony Novak, CPA, MBA, MT
, revised 11/21/11

March 30, 2004 - Health Savings Accounts are only three months old but have already made a significant impact on the design of employee health benefit programs. The Bush re-election campaign names HSAs as one of a three-pronged attack on the nation’s health care problem (the other two prongs are medical liability reform and association health plans). In other circles, HSAs have been tagged as just another tax shelter for the rich. But practitioners in the employee benefits industry report interest in HSAs is stronger and more widespread than any other health plan innovation to date. The IRS marked the occasion today by issuing three clarifying publications about HSAs.

In summary, an HSA works like this: A healthy person drops their current health insurance plan and switches to a special new insurance specifically designed for this program. High-risk applicants are not eligible for this type of health insurance. The new HSA-qualified insurance costs about 30% less than the former insurance. A covered person may then open an account similar to an IRA and make tax-deductible deposits. The employer may also make contributions. Withdrawals may be taken tax-free at any time to cover health expenses not paid by insurance. The income tax savings average about $1000 per year for a typical HSA owner.

HSAs are most popular with self-employed individuals who buy their own health insurance. They like to keep the required insurance cost low while reserving the option to make a larger tax-deductible contribution to an HSA account if funds are available. The unfortunate statistic is that the majority of people in the self-employed category are financially struggling to meet basic expenses and have a hard time affording any health insurance – with or without an HSA. As a result, the benefits realized tend to fall short of expectations. Affluent self-employed persons consider the switch to HSAs to be an easy decision and welcome the immediate tax break and the opportunity to make additional tax-free investments.

The main problem with HSAs is that the saving in insurance cost is small compared to the risk posed by the high policy deductible. This is because HSA-qualified plans rely on a more expensive type of that insurance called “commercial indemnity” that bases eligible coverage on a private physician’s recommendation. In contrast, HMOs are able to keep insurance costs lower by legally overriding doctors’ recommendations. If the insurance savings is $100 per month as compared with a full coverage HMO, but the policy deductible of the HSA plan is $5000, it takes 4 years of no claims months to break even. On the other hand, HSA-qualified insurance takes many of the hidden costs out of health care so the coverage gap might not be as large as it appears. HSA insurance plans may not use “per person” deductibles (often a problem in family plans), or charge co-payments for doctor office visits or prescription drugs. It is generally believed that the out-of-pocket costs for a household with “full coverage” health insurance is about $1,200, so this narrows the gap between HMO and HSA total costs¹. The Treasury clarified that HSA insurance plans may provide preventative care benefits and state-mandated coverage without violating federal requirements. This clarification might encourage more insurance companies to offer this type of health insurance plan but for now the choices are extremely limited.

Another problem is that the majority of people who opened Health Savings Accounts so far this year did not enroll in qualifying insurance but kept their previous high deductible insurance. At this time the IRS has not said how it will track the tax cheaters.

For small businesses, philosophical acceptance of HSAs is more widespread but implementing changes within group plans takes time. The current topic of discussion is whether to offer HSA plans as an option alone or combine them with a Health Reimbursement Arrangement (HRA) or Flexible Spending Account (FSA). At this time it appears that HRA plans hold a slight advantage over HSAs and FSAs for businesses providing health coverage to employees.

HSAs will not replace the managed care approach, but are a welcome tax break for healthy affluent individuals who insist on maintaining complete freedom of choice with regard to health care decisions.

***

Footnotes

¹ A detailed example of a calculation of HSA savings for a typical household is published at www.healthsavingsaccount-hsa.com

Status: outdated information but historically accurate

This article has not been edited or updated and should be considered to be out-of-date and not available for republishing at this time.