With the talk of “repeal and replace” for Obamacare on the front burner, it’s essential for small business owners to understand health savings accounts (HSAs). The reason: HSAs are being discussed as the cornerstone for possible new law. What’s more they can be used now under the Affordable Care Act (ACA) by companies large and small.
Here’s where we stand now.
Overview
Health savings accounts (HSAs), as the name implies, are accounts designed to save money to pay for medical costs that are not covered by insurance. As of the last census, there were 19.7 million people with HSAs, up from 17.4 million the year before. So HSAs are clearly growing in popularity. One reason is because they offer big tax breaks:
- Contributions are tax deductible. If contributions are made by employees, deductions are claimed in their personal returns; no itemizing is required. If contributions are made by the employer, they are a business deduction.
- Earnings are tax deferred. While the funds remain in the account, there is no tax on the earnings.
- Qualified distributions are tax free. Funds used to pay qualified medical expenses are not taxed. The category of “qualified expenses” is quite broad, and includes dental and vision care,
- Employment tax savings. Employer contributions to employees’ accounts are not treated as taxable compensation. Thus, there are no payroll taxes on the contributions. This does not change merely because such contributions are reported in box 12 of Form W-2.
High-deductible health plans
A prerequisite for contributing to HSAs is having a high-deductible health plan (HDHP). This plan is defined by tax law. For 2017, it means having an annual deductible and limits on out-of-pocket costs (deductibles, co-payments, and other amounts except HDHP premiums). These amounts vary with the type of coverage:
- Self-only coverage (a plan that covers only an individual): Deductible of $1,300 and cap on out-of-pocket costs of $6,550.
- Family coverage (a plan that covers an individual plus one other person, such as a spouse or dependent): Deductible of $2,600 and cap on out-of-pocket costs of $13,100.
In Marketplace parlance, an HDHP had been a bronze plan where premiums are modest but the annual deductible was higher than with other types of plans. However, due to changes in the offerings through the Marketplace for 2017 coverage, the deductible under the bronze plan is too high to be an HDHP; deductibles under the other metal-level plans are too high. It is not clear to me whether an HDHP can now be obtained through the Marketplace or whether only privately sold policies can qualify.
An HDHP is not disqualified merely because it covers certain preventive services, such as well-child care and immunizations, with no deductibles for these services.
Contribution limits
The amount that can be added to an HSA each year is limited. For 2017, the contribution amount is $3,400 for a person with self-only or $6,750 for family coverage. Anyone who is at least 55 years old at the end of the year can add another $1,000 to the contribution limit.
However, no contributions can be made for a person who is covered by another health plan (there are some exceptions) or is enrolled in Medicare. Someone claimed as a dependent on another taxpayer’s return is ineligible for an HSA.
Other benefits for employees
In addition to the tax breaks discussed earlier, employees can benefit in other ways from HSAs:
- Portability. From day one, the account belongs to an employee. Thus, leaving a job does not mean leaving the HSA behind.
- Changes in coverage. While contributions can only be made when there is an HDHP in place, if coverage changes so that the insurance no longer comports with HDHP requirements, the account can continue in existence. Of course, no new contributions can be made until another HDHP is in place.
- COBRA (continuation coverage). While HDHP premiums paid by an employee do not count as a qualified expense for which distributions are tax free, funds in the HSA can be used to pay COBRA premiums for an employee who continues group coverage after leaving employment.
- Retirement savings. Funds in the account need not be used exclusively for medical costs, although only these types of expenses are tax free. Distributions can be taken for any purpose, although there is a 20% penalty for non-medical withdrawals before age 65. Once the account owner has attained age 65, there’s no longer any withdrawal penalty even though funds are used for vacation, home improvements, or any other non-medical purposes.
Other benefits for employers
In addition to deductibility for employer contributions and savings on employment taxes, there are other benefits:
- Law compliance. Applicable large employers can meet their employer responsibility under ACA by offering an HDHP. Even if ACA is repealed, any transition probably won’t eliminate the employer responsibility for 2017, so HDHPs are worthy of attention for the time being.
- Affordability. Smaller employers that are not required by law to offer health coverage or pay a penalty but want to provide medical care for their staff can probably do this on a cost-effective basis through an HDHP combined with HSAs. Small employers still weighing 2017 coverage should discuss this with their benefits advisor.
Final thought
A GOP plan for improving health care was released last June. It said that reform would include improving the flexibility for HSAs, but offered no details. President-elect Trump as also touted the use of HSAs, but again without giving any details about how they might be expanded under health care reform. Until such time as reform occurs, which likely will be phased in, employers must rely on existing law. Find more about health savings accounts as they now stand in IRS Publication 969.
