Coverdell Education Savings Accounts (CESA)

Health Savings Accounts

Major highlights of Health Savings Accounts (HSA) include the following:

• Individual contributions may be deducted from gross income by the HSA owner.
• Employer contributions are deducted as an "Employee benefit deduction" and . . . 
  • Are not subject to employment taxes such as FICA and other tax withholdings. 
  • Are not reported as income to the employee (contributions to an employee's HSA do not appear as income). 
  • HSA owners do not deduct on their tax returns employer HSA contributions. 
• No "Use or Lose" provision: Money may accumulate until used.
• Portable: The HSA owner may move the money when changing employers.
• Tax-free earnings: Interest or earnings on HSA money is not taxed.
• Tax-free distributions: Distributions are tax free if used for qualified medical expenses.
• No income limits:  Anyone may contribute to an HSA regardless of income.
• No earned income restriction: Income from any source may be contributed to an HSA.
• Not subject to ERISA:  The Department of Labor says that HSAs will not be subject to Title 1 liability under ERISA, regardless if the employer opens the account or pays fees in behalf of the employee, or limits the number of withdrawals.

More information:  IRS Publication 969 - Health Savings Accounts and other tax-favored Health Plans.

Health Savings Accounts at State Bank

State Bank's HSA is a savings account!  

• No special tickets. Our normal Savings withdrawal and deposit tickets are used.
  •  A deposit counts as a contribution.
  • A withdrawal counts as distribution.
• Withdrawals or deposits may be for any amount.
• A limit of 6 withdrawals (distributions) are allowed per month, same as regular savings. 
• Excess withdrawals are charged $5 each.
• Checks and debit cards are not allowed.

State Bank is not responsible to control the contributions or distributions.  You may take a distribution for any purpose, but you are responsible for tracking expenses, maintaining receipts, and any possible tax consequences for unqualified distributions.

Basic Philosophy of Health Savings Accounts

Remember the old days when the patient pulled out his wallet to pay the doctor's bill?   This doesn't happen much nowadays because people expect someone else to pay medical bills, which has led to very unhealthy trends in health care.  

Supply and demand never balance when people are insulated from the consequences of economic choices.   Prices may rise, but people don't change behavior when someone else bears the cost.  This is one reason medical insurance premiums have risen dramatically over the past 20 years. 

The Health Savings Account (HSA) offers hope because it puts people back into the position of feeling the consequences of medical choices.  Someone else (an insurer) starts to pay after individuals have spent a significant amount of their own money.

Qualifying for a HSA

HSA's have qualifying rules, as follows:

• Money must be held by a trustee, such as a bank.
• Accounts must be specially designated as Health Savings Accounts. 
• Account must be in the name of one individual as the sole owner. 
  • Other convenience signers may be listed as "SGN" or "OTH" . 
  • No trust owners or business entity owners.
• The HSA owner must have a high-deductible health plan (HDHP), which is discussed later.
• And the HSA owner . . .
  •  Is not covered by any other health plan with very few exceptions.
  •  Is not 65 or older, or if so, not enrolled in medicare.
  • Cannot be claimed as a dependent.

Deposits are contributions.  Withdrawals are distributions.  A teller may handle these because regular savings tickets are used.   New Accounts personnel handle transfers.  Unspent money remains in the account where it can grow tax free through the lifetime of the owner. 

SBSU will open an HSA account for anyone who wants one.   However, you should ask for information so you can make the correct choice.

Two Parts to Health Savings Accounts

A Health Savings Account is only half of the equation.   Two parts are required,  as follows:

1. A High-Deductible Health Plan  (HDHP).
2. An account at a bank specifically designed as a Health Savings Account

Requirement #1: The High Deductible Health Plan (HDHP)

A high-deductible health plan is a fancy way of saying, "Health insurance that doesn't pay anything until a lot of money has been spent by the owner".   It is a type of insurance that remains in the background until the owner spends enough of his own money to meet the deductible.  And then the insurance kicks in.

The chart back on page 2 shows the minimum and maximum deductibles in order for an insurance plan to be eligible for a Health Savings Account.   Individuals should obtain HSA eligible insurance before opening a HSA.

Requirement #1: The High Deductible Health Plan (HDHP)

A person cannot be covered by other health insurance except for the following types of limited-coverage plans, as follows: 

• Wellness programs that pay limited amounts toward preventative care.
• Disease management programs (cannot pay significant benefits).
• Disease or accident insurance that covers only specific situations such as . . .
  • Vision, dental, or long-term care insurance
  • Accident, cancer, or disability (think AFLAC).
• Drug discount cards are OK.
• Eligibility for VA benefits is OK, but a person cannot actually have received benefits within the last three months.

HSA money cannot be used to pay HDHP insurance premiums.

Requirement #2: The HSA

After obtaining appropriate insurance, individuals may open a Health Savings Account at SBSU.  There is nothing special about the account except for the following:

• It's a savings account flagged as an HSA. 
• An account designated as an HSA can never be changed.  It may be closed, but never changed to another account type.
• Deposits are contributions
• Withdrawals are distributions.

Funding the HSA

Contributions to the HSA may come from the individual, others, or employers up to 100% of the health plan deductible.  Contributions to the HSA carry different tax benefits, depending upon who makes the contribution, as follows:

• Contributions by self may be deducted from the HSA owner's gross income.
• Contributions by others may also be deducted from the HSA owner's gross income.  
• Employer contributions made to the HSA owner's account are not tax deductible.  But, the money is . . .
  • Excluded from gross income of the worker (employer contributions do not appear as employee income).
  • Not subject to employment taxes (FICA is not withheld).

Employers hope that HSAs help drive health costs down because money in the HSA belongs to the individual, which is the grand idea behind Health Savings Accounts.  Ideally, individuals will not only be more selective when spending their own money, but will also avoid costly lifestyle errors such as over-eating or substance abuse.

Qualified Health Care Distributions

What can HSA money be spent on?   Qualified distributions include the following:

• Out of pocket medical expenses
• Prescription drugs
• Certain over-the-counter medication
• Doctor's fees not covered by insurance
• Co-payments that are sometimes added to the charges for a visit to the clinic
• Dental and eye expenses
• Spouse or dependent medical expenses even if they are not covered by the HDHP  
• Certain long-term health insurance premiums (see a qualified tax advisor)
• Can be used for prior-years' medical expenses if the HSA was established then and the expenses were not reimbursed by another source or taken as a medical deduction

Caution:  HSA money cannot be used to pay health insurance premiums or specific-event insurance (vision, dental, accident, cancer, etc.).  Distributions used for those purposes will be taxed as ordinary income and subject to a 10% penalty.

Three Points about Qualified Health Care Distributions

First, a co-payment is a qualified medical expense under HSA rules.  However, the HSA owner is also responsible for paying for treatment costs in addition to the co-payment.   Some insurance plans may not allow a co-payment to count toward meeting the deductible. 

Second, medical bills for one year may completely drain HSA resources without meeting the insurance deductible.   In those cases the HSA owner may use his next year's HSA contribution to pay a prior year's medical expense if not reimbursed by another source or taken as a medical deduction on a tax return.

Third, some HSA expenditures, such as vision or dental expenses, may not count toward a particular type of HDHP deductible, but do count as qualified medical expenses under HSA rules.  Some insurance plans require specific types of medical costs to count toward the deductible.   While the IRS "qualifies" certain types of medical expenses, insurers may not follow the same IRS list for meeting the deductible. 

Qualified Health Care Distributions continued . . .

HSA distributions for qualified medical expenses are tax and penalty free.   However, distributions for unqualified expenses are added to the owner's gross income and taxed at regular rates plus an additional 10% penalty.  The individual can spend the money on anything, really, but it is up to him to keep accurate records to prove the distributions went toward qualified health expenses.  The 10% penalty for unqualified distributions remains in force until the individual . . .

• Dies or becomes disabled (distributions are still taxed as income).
• Turns 65 years of age (distributions are still taxed as income).

In other words, unqualified expenditures from an HSA are always subject to regular income tax.  They are usually subject to an additional 10% penalty unless the person has died, become disabled, or turned 65 during the year. 

Mistaken distributions from an HSA:  Money may be re-contributed to the HSA by April 15 of the year after a person should have known it was a mistake.  However, clear and convincing evidence is required that proves the distribution was an honest mistake, not a "planned" error.

This is another reason why a person with an HSA must keep receipts and maintain good records.

HSA Beneficiary Options

SEP IRA

This is very simple because there are so few options.   A spouse may inherit the HSA from a deceased partner and "treat as own" without tax consequences. The HSA is simply transferred to an HSA in the name of the surviving spouse.

Non-Spouse beneficiary:

• An "Inherited HSA" is set up in the name of the beneficiary and funds distributed under beneficiary's name and SSN.
• Beneficiary adds the distribution to gross income on his or her tax return.
• The money is taxable at ordinary rates, but the 10% penalty does not apply for death distributions.
  • Taxable amount may be reduced by qualified medical expenses incurred by the deceased person before death and paid by the beneficiary of the HSA (burial costs are not qualified).
  • The taxable amount will also be reduced by the amount of estate tax paid due to inclusion of the HSA into the deceased individual’s estate.