Will Health Savings Accounts Have A Market? So far they have enjoyed a better initial response than MSAs.
New way to pay for health care that combines an insurance component with an intriguing savings kicker was introduced by the Medicare Reform Act in December. 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. Otherwise, they are subject to income tax as well as a 10% penalty for those under age 65. This equivalent of a tax home run-tax-deductible contributions, tax-free accumulation of earnings, and tax-free withdrawals-is unique to any type of savings plan.
Funds not used in one year can be carried over into the next and are portable. 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, mutual funds or stocks.
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 limited appeal. This time around, observers are a bit more optimistic. "A lot of carriers stayed on the sidelines with the MSA because of sunset provisions and enrollment restrictions," says David Evans, vice president of the Independent Insurance Agents and Brokers of America, a trade organization representing health insurance agents. "We're seeing a better initial response from insurers to health savings accounts."
"Savers" And "Spenders"
If the precedent set by the Archer MSA is any indication, some people are likely to use contributions to health savings accounts to pay for health care expenses while others will maximize their use as a tax-sheltered savings and investment vehicle. Under an ideal health savings account "savers" scenario, someone might pay all or most medical expenses with after-tax dollars, leave the monies in the health savings account to grow largely untouched, and reach age 65 with a sizable account balance. At that point, he could withdraw the money tax-free to pay for long-term-care insurance or expenses not covered by Medicare. Or, he might decide to use all or part of the account for living expenses or a vacation, and pay income taxes on the withdrawals used for those purposes. Even if withdrawals are eventually subject to income taxes, tax-deductible contributions and tax-free accumulation of earnings provide savings incentives and benefits similar to those offered by 401(k) plans.
In reality, however, most people cannot afford to pay uninsured medical expenses with after-tax dollars, and leave their HSAs alone. According to the IRS, 73% of MSA accounts are set up by those who had been uninsured for six months or more and who probably have no other options. Initially, the most likely candidates for health savings accounts will be the self-employed, the uninsured and those working for smaller companies who might not otherwise be able to afford a higher-cost, traditional health insurance plan. This "spenders" group will pay the lower premiums associated with a high-deductible health insurance plan. If they have some financial leeway, they might contribute all or part of their premium savings over a traditional plan to a health savings account, and use most of the account to pay for ongoing medical expenses.
Whether or not financial services providers will pair up with health insurers to offer HSAs will depend to a large extent on how many people will fall into the "savers" category. For those in a financial position to consider such a strategy, the question is whether or not the tax advantages offered by health savings accounts, combined with the premium savings policy holders realize by opting for a high-deductible policy, outweighs the monetary and emotional costs associated with shouldering a higher portion of one's medical bills. Financial advisors or their clients who are considering using a health savings account should consider several factors:
Health. Younger, healthier individuals with few medical expenses are obviously better candidates for high-deductible policies than are those with more pressing medical needs, such as young families or those with chronic illnesses. But even a healthy individual could suddenly develop an expensive, chronic illness and get stuck paying the maximum deductible for a very long time. At that point, the door to a more traditional health plan may already be closed because of a pre-existing condition. "The question," says Evans, "is whether or not you are willing to roll the dice. The big variable here is someone's health care utilization."
Wealth. The tax benefits of HSAs are obviously more valuable to those in higher tax brackets. The savers strategy also works best if you are fairly certain that your income and assets are substantial enough to pay medical expenses up to the deductible for an extended period, should the need arise.