Health Savings Accounts (HSAs) provide a tax-favored way to save for and pay for medical expenses. HSAs can be established by individuals who participate in high deductible health plans (HDHPs), or by employers that offer an HDHP option for health care coverage, in which case HSA eligibility is limited to employees who choose the HDHP option. Either the employer or the individual, or both, can make contributions to the HSA. Amounts paid from an HSA for qualified medical expenses are distributed tax-free.This article summarizes IRS guidance on HSA dollars—the requirements for contributions made to HSAs and for distributions made from HSA accounts.
Either the employer or covered individual can make contributions to the HSA. Employee contributions are deductible (or paid pre-tax through salary reduction in a cafeteria plan) and employer contributions are excludable from the employee's gross income. HSA contributions are limited to $3,050 for individuals/$6,150 families (2010 limits, indexed annually, with larger amounts permitted for individuals age 55 or older).
Employer contributions made on behalf of all "comparable participating employees" must themselves be comparable. Notice 2004-50 provides examples of application of the comparability requirement, which indicate that this requirement is interpreted very literally:
The comparability rules do not apply to HSA contributions made through a cafeteria plan (but these contributions would be subject to the nondiscrimination rules for cafeteria plans).
HSA distributions used to pay for qualified medical expenses are excluded from income. "Qualified medical expenses" generally include those expenses as defined in Sec. 213 of the Tax Code. A notable exception is health plan premiums, which generally cannot be paid from an HSA. However, certain types of premiums can be paid from an HSA: long-term care insurance premiums, up to applicable age-based limits (even if employee HSA contributions are made through a cafeteria plan); COBRA premiums; health care coverage premiums while an individual is receiving unemployment compensation; and premiums paid by individuals over age 65 for Medicare or for employer-sponsored health insurance or retiree health insurance (but not for Medigap policies).
HSAs can also pay for long-term care services, whether or not the HSA is funded through a cafeteria plan.
Distributions that pay for the medical expenses of the accountholder's spouse or dependents receive favorable tax treatment, even if these individuals are not covered by an HDHP.
There is no time limit by when a distribution must be taken to pay for or reimburse a qualified medical expense (i.e., no carryover rules, such as those commonly found in health plans or cafeteria plan flexible spending accounts). However, the HSA cannot pay for expenses that were incurred prior to the time that it was established.
Overall, the distribution rules for HSA take a generous approach. Together with the clarifications on HSA contributions, these accounts present an attractive option for employers looking to better define their health care dollars.
