A new way to pay for health care that was introduced by the Medicare Reform Act in December combines an insurance component with an intriguing savings kicker. The new plans, called health savings accounts (HSAs) are designed to help individuals save for qualified medical and retiree health expenses on a tax-favored basis. Contributions to these accounts are federally tax-deductible, and earnings accumulate tax-free. Withdrawals are also tax-free, as long as they are used to pay for qualified medical and retiree health expenses. This equivalent of a tax home run—tax-deductible contributions, tax-free accumulation of earnings, and tax-free withdrawals—is truly unique to any type of savings plan.
The major catch: HSAs must be used in conjunction with a high-deductible health insurance plan, which shifts a greater share of medical costs from insurance companies to individuals and families. For individuals under age 65 who purchase self-only policies, a qualified health plan must have a minimum deductible of $1,000 with a $5,000 cap on out-of-pocket expenses. For family policies, a qualified health plan must have a minimum deductible of $2,000 with a $10,000 cap on out-of-pocket expenses. These amounts are indexed annually for inflation. A taxpayer must be under age 65 to open an account.
Beginning January 1, health savings accounts replace Archer MSAs, an earlier type of medical savings account that never really took off because of its restricted availability and complexity. Below are some notable features of the newer, more user-friendly HSAs:
• Beginning this year, individuals can make annual tax-deductible contributions of as much as $2,600 ($5,150 for families) to a health savings account, regardless of whether they itemize on their Federal tax returns. Employer contributions are made on a pretax basis and are not taxable to the employee. This means employers can make deposits to HSAs on behalf of employees, and receive the full employer health insurance deduction for such deposits. Currently, 23 states permit tax deductions for contributions to Archer MSAs, according to Scott Krienke, Vice President of individual medical services with Fortis Insurance, an early entrant into the HSA market. Krienke anticipates that many of these states will amend their laws to allow tax-deductible contributions to HSAs as well.
• In addition to the maximum contribution amount, individuals between age 55 and 65 may make additional “catch up” contributions of up to $500 in 2004, increasing to $1,000 annually in 2009 and thereafter. A married couple can make two catchup contributions as long as both spouses are at least age 55. The maximum amounts are indexed annually for inflation.
• Distributions made for non-medical purposes are subject to income tax and a 10 percent penalty. The penalty is waived for distributions made by individuals age 65 and older, or in the case of death or disability. Medical expenses that qualify for tax-free withdrawal treatment include amounts paid for the diagnosis and treatment of disease, prescription drugs, long-term-care insurance and long-term-care services, continuation coverage required by Federal law under COBRA, and health insurance for the unemployed.
• Funds not used in one year can be rolled over into the next to help pay for future expenses. This treatment differs from more familiar flexible spending accounts, whose “use or lose” provisions require participants to empty their accounts each year. Money in flexible spending accounts also earns no interest. By contrast, health savings account investments can include interest-bearing securities or mutual funds.
• The maximum annual contribution to the health savings account may not exceed the amount of the deductible, and is computed monthly. For example, if the annual deductible for a individual policy is $2,600, the maximum monthly contribution to the health savings account in 2004 would be $216.67 ($2,600/12). This means that if one opens a health savings account on June 1, one can contribute a maximum of $1,516.69 ($216.67 x 7) for that year. Although the annual contribution is determined monthly, the maximum contribution may be made on the first day of the year.
Also in This Issue:
Health Savings Accounts (Continued)
Quarterly Review of Investment Policy
Fourth Quarter Economic Review
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
Asset Class Investment Vehicles
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