How to Take Advantage of Health Savings Accounts

Establish custodial HSAs that are tax-free to both your business and employees.

Q: I've heard that the old Medical Savings Account has been replaced by a new, expanded version that allows employers to assist their employees in accumulating tax-free dollars that these employees can use to pay for certain qualified medical expenses. Is this true, and what is this new plan?

A: Yes, it's true. Effective Jan. 1, 2004, individuals (under age 65) may establish Health Savings Accounts (HSAs)-custodial accounts allowing them to save for qualified medical and retiree health expenses on a tax-free basis. The individual, called an "account beneficiary," must (for the months the HSA contributions are made) be covered under a high-deductible health plan (HDHP).

Any eligible individual can establish an HSA. For HSA purposes, an eligible individual: (1) is covered under an HDHP; (2) is not also covered by any other health plan that is not an HDHP; (3) is not entitled to benefits under Medicare; and (4) may not be claimed as a dependent on another person's tax return.

For 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 contributions are allowed up to 100 percent of the health plan deductible. The maximum annual HSA contribution for 2004 is $2,600 for self-policies and $5,150 for family policies. The monthly maximum contribution is equal to 1/12th of the above, computed each month. Individuals age 55 to 65 may make additional "catch-up" contributions of up to $500 in 2004, increasing in $100 annual increments to $1,000 annually in 2009 and thereafter.

Contributions made by individuals and family members are tax-deductible for the account beneficiary-even if the account beneficiary does not itemize. HSA contributions are not on a "use or lose" basis (meaning the account beneficiary does not lose his or her unused HSA dollars at the end of each year-such as was the case with the old Medical Savings Accounts). Employer contributions are made on a pre-tax basis and are not taxable to the employee. Employers will be allowed to offer HRAs through a cafeteria plan; however, these employer contributions must be made available on a comparable basis, on behalf of all participating employees.

Contributions must be made with a qualified HSA trustee or custodian-much in the same way that individuals establish IRAs. Your HSA trustee or custodian can be an insurance company, a bank or other similar financial institution as defined by the IRS. All existing already approved IRA trustees or custodians are automatically approved as an HSA trustee or custodian. Note: Your HSA does not have to be opened at the same institution that provides the HDHP.

HSA distributions are tax-free if they are used to pay for qualified medical expenses, such as: (1) amounts paid for the diagnosis, cure, mitigation, treatment or prevention of disease; (2) prescription drugs; (3) qualified long-term care services and long-term care insurance; (4) continuation coverage required by federal law; (5) health insurance for the unemployed; (6) Medicare expenses (but not Medigap); and (7) retiree health expenses for individuals age 65 and older. (Note: Retiree health plans would not have to meet the $1,000/$2,000 minimum deductible requirements.)

Distributions made for any other purpose are subject to income tax and a 10 percent penalty. The 10 percent penalty is waived in case of death or disability. The 10 percent penalty is also waived for distributions made by individuals age 65 and older. And, upon death, HSA ownership may transfer to the spouse on a tax-free basis.

Note: The information in this column is provided by the author, not All answers are general in nature, not legal advice and not warranted or guaranteed. Readers are cautioned not to rely on this information. Because laws change over time and in different jurisdictions, it is imperative that you consult an attorney in your area regarding legal matters and an accountant regarding tax matters.

David Meier received an MBA in Finance from Loyola of Baltimore, and spent much of the 1970s teaching business courses; later, he created a consulting group, and for the next two decades, provided accounting and tax services to small-business owners. He is currently the founder and COO of Business Development Coaching, which provides small-business owners with ongoing business coaching and the knowledge and support required to enable them to become truly successful entrepreneurs. Visit his site at

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