Health Savings Accounts help taxpayers gain control of health care costs By Lauren Brimmer - The North County CA Times

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Used to be, the only way for the average American to avoid taxes was to earn money in cash and stuff it in a mattress for safekeeping.  Now, in what has been called "the most sweeping and beneficial changes in half a century," the federal government has come up with a completely legal method of tax avoidance that even earns interest.  It's called an HSA or health savings account.

Often called a "Medical IRA," health savings accounts are special accounts owned by individuals that allow tax-advantaged contributions to pay for current and future medical expenses.  They were created as part of the 2003 Medicare Prescription Drug, Improvement, and Modernization Act, the same legislation that created Medicare Part D.

"An HSA is for anyone who is willing to sit down and look at the big picture over the course of the year," said Fred Adams, vice president of sales for HSA for America, an insurance broker that operates in 40 states, including California.

Adams advises clients to look at health insurance premiums, out-of-pocket expenses, and tax benefits of their various health care options.  "When you do that," he said, "you come up with the net cost of taking care of your health, and it's hard to come up with a scenario where you don't come out ahead with an HSA."

Lots of people seem to agree: 3.2 million Americans are covered by HSAs as of January 2006, representing a seven-fold increase in the number of accounts since November 2004, according to America's Health Insurance Plans, a trade organization of insurers.  The group notes that 31 percent of those opening accounts were previously uninsured, and 33 percent are small businesses not previously offering a health insurance benefit.

Americans have already invested more than $1 billion in their HSAs, and both the number of accounts and dollars invested are expected to continue to skyrocket, according to Treasury Department estimates.

By 2010, 14 million accounts covering 25 million to 30 million people are projected to be in use, assuming current laws.  Favorable changes proposed in President Bush's 2006 health care initiative increase Treasury's estimate 50 percent.  Proposals include allowing individuals to deduct health care premiums from their HSA accounts.  This would benefit any taxpayer whose employer doesn't offer health insurance.

HSAs may be even better than an IRA from a tax perspective, since neither contributions nor withdrawals are taxed.  Savers who don't care to put their funds at risk can often opt for a lower guaranteed return in an insured account.

"The idea in creating HSAs was to give Americans an incentive to take control of their own health care and to provide increased flexibility so that employees aren't bound to their employers by health care needs," said Sean Kevelighan, a spokesman for the U.S. Treasury Department, the agency that issues guidance on HSAs.

"That's why the creation of HSAs was so important," he continued.  "It was historic, really, because it embraces a philosophy that favors the individual, versus an employer or the government."

By contrast, Flexible Spending Account that many employees know about have a "use it or lose it" feature that has actually encouraged unnecessary health care expenditures to avoid forfeiting money at year-end.

Must combine with high deductible health plans

Individuals can get a health savings account through a financial institution such as a bank or credit union or sign up via their employer. Its companion, a high deductible health plan (health care insurance), has to already exist to open the HSA.  Similar to IRAs, HSAs are owned by individuals, and they are portable.

This portability is a key feature. If an individual changes employers or leaves employment, the HSA stays with the individual, and no money is forfeited.  This is a major protection for individuals as they save for longer term health care needs.

Critical to understanding the value of HSAs is an understanding of the coverage that high deductible health plans provide.  An HDHP represent a different philosophy of health care.  Rather than offering blanket coverage, they are inexpensive catastrophic health plans that provide a safety net of coverage against a wide range of serious health problems and accidents.

Out-of-pocket costs for deductibles, co-pays, prescription drugs, and even many over-the-counter medicines can be paid for using the funds in the HSA as well as long-term care insurance premiums and insurance premiums paid during a period of unemployment.  The premise is that individuals managing their own care will make better decisions and shop around for the best value.

I am a perfect example of this principle.  Last week, I visited my doctor after a long period of repeated upper respiratory illness.  Prescription in hand, I went to Fallbrook Pharmacy, the lowest-cost pharmacy of three I queried.  Fallbrook Pharmacy charged $44.95 for my prescription, versus quotes of $148.98 at Rite Aid in Oceanside and $199.99 at Drugstore.com, for a saving of $104.03 (paid from pre-tax earnings) for my seven-minute investment.

Like most HSA providers, mine provides a debit-style VISA card I can use for purchases up to the balance of my account.  No additional paperwork is required, although I'll want to file the receipt showing that I paid a qualified expense from the account, in case of an IRS audit.

HDHPs provide big savings

For individuals and businesses, the greatest selling point of high-deductible insurance is its low monthly premium.  A young, healthy single person might pay only $50 per month for a plan with a $5,100 maximum annual out-of-pocket cost for a Blue Cross of California plan.  That same person might pay $250 per month or more for a plan with a very low deductible.

With 73 percent of Americans incurring less than $500 per year in annual medical expenses, a lot of people are probably carrying more health insurance than they need, according to Adams.

With an HSA/HDHP combination, people pay a low "just in case" cost should they have a major illness.  The rest of the time, they manage their own health care consumption, paying for routine medical care only as needed out of tax-free contributions they or their employers make to HSAs.

Successful so far

Early evidence shows signs of success on every front for HSAs coupled with high-deductible health care options.  Nearly one-third of enrollees did not previously have health insurance.  And on the cost front, premiums for high-deductible plans increased an average of only 2.8 percent from 2004 to 2005.  This compares to an increase of 8 percent for health maintenance organizations, and 7.2 percent for preferred provider organizations, according to a recent study by the Deloitte Center for Health Solutions, which surveyed 152 major employers.

California is 'nonconforming'

Unfortunately for California taxpayers, HSA contributions will be deductible only against federal income in 2005.  California is one of only a handful of nonconforming states, meaning that California filers will get the deduction on only their federal tax returns.

Tom Kise, a spokesman for state Sen. Abel Maldonado, expects conformance in 2006.  "Sen. Maldonado remains optimistic that we'll pass a bill," he said, noting that HSAs have proven themselves as a way to move the uninsured to insured status by providing reasonably priced options.

Senate Bill 1584 is co-sponsored by Republican Sens. Maldonado and George Runner of the 17th District.

HSA Fact Sheet

• Individuals and anyone who receives health insurance as an employee benefit can open an HSA, but health insurance must be in the form of an approved high deductible health plan (HDHP).  Ask your insurance carrier or agent which plans qualify.
• To open an HSA, first establish a high deductible health plan (HDHP).  Funds from the account can then be used for any qualified medical expenses not covered by insurance
• By federal mandate, the maximum amount an insured must pay before the HDHP pays 100 percent of remaining in-network expenses is $5,250 for individuals and $10,500 for families of two or more.  In practice, current industry averages are $3,371 and $6,837 for individuals and families, respectively.
• By federal mandate, HDHPs must have an annual deductible of at least $1,050 for individual (self-only) coverage or $2,100 for family (more than one individual) coverage.  Except for limited preventive care, the deductible must be met before the plan pays any benefits.
• Once an account owner turns 65, money can be used for anything, with no taxation at withdrawal, although no further HSA contributions can be made.
• 2006 contribution limits: single ---- $2,700; family coverage ---- $5,450.  This is an "above the line" deduction that reduces taxable income, even if you don't itemize.
• Year 1 contributions are prorated. Example: An account set up July 1 can contribute 50 percent for that year.
• Individuals 55 or older can make an extra $700 catch-up contribution in 2006, increasing by $100 per year until 2009. Most HSAs provide a debit card the account owner can use to pay qualified medical expenses. The card's value is equal to the balance of your account. IRS Publication 502 contains a complete list of qualified expenses.
• HSA money used for any other reason requires payment of income tax plus a 10 percent tax penalty on the amount used (you will not pay a penalty if you are disabled or age 65 or older).

Health care history

Attaching health care coverage to the workplace is a relic of World War II, when companies subject to wage and price controls and thus unable to raise wages used health insurance to attract workers.  To help these employers afford the new benefit, Congress later made employer-provided insurance tax-deductible, and by the 1960s, health care was a fairly universal employer benefit.

But those were the days of lifetime employment and comparatively low health care costs.  Employees got a tax-free insurance benefit, with little or no incentive to compare costs.  Employers paid a reasonable price that was fully tax-deductible.

Today, employees switch jobs with far greater frequency and must switch health care plans each time, and only about 60 percent of employees receive any form of health coverage.  Employees who are sick or have a sick family member must shop jobs based on health care availability.  In the worst-case scenario, an employee gets sick and, unable to continue working, loses health care entirely after high-priced COBRA coverage terminates.