Health Savings Accounts (HSAs) Booming in Popularity - Are They Right for You?

HSAs Explained

The Medicare Act of 2003 created a new tax-deferred savings account to fund medical expenses known as HSAs. Doctors under the age of 65 who participate in a qualifying high-deductible health insurance policy can fund tax-deductible contributions to an HSA to cover future medical expenses. Under the law an individual "self-only" policy is considered a high-deductible plan if it has a minimum deductible of $1,100 for individuals and $2,200 for family coverage. These minimum deductibles do not apply to preventative care services, nor do they cover amounts spent for accident, disability, dental, vision care, and long-term care. Thus, the policy may qualify even though the HSA has no deductible, or a lower deductible, for these additional covered services.

Tax-deductible Contributions

Doctors can contribute and deduct an amount up to a maximum of $2,850 for a single policy and $5,650 for a family policy in 2007. In addition, doctors and spouses age 55-64 can make additional tax-deductible "catch up" contributions of $700 per spouse in 2006 (not $600 as noted in our October 2006 issue), $800 per spouse in 2007, $900 per spouse in 2008, and $1,000 per spouse thereafter.

Tax Deferred Growth/Tax-free Payouts

Amounts contributed to an HSA can be invested in stocks, bonds, mutual funds, etc., and the earnings grow tax-free. In addition, distributions from HSAs to pay for qualified medical expenses are also tax-free. "Qualified medical expenses" include all amounts defined as medical care under Section 213 of the tax law.*

If the doctor withdraws HSA funds before age 65 for items other than qualified medical expenses, the amounts withdrawn are taxed as regular income and a 10% penalty also applies. Once the doctor reaches age 65, amounts withdrawn for items other than qualified medical expenses are taxed as ordinary income, but the penalty no longer applies.

At the doctor's death, the ownership of the HSA can be transferred to his or her spouse on a tax-free basis. Otherwise, the account ceases to be an HSA at the death of the doctor and the value of the account is included as income in the beneficiary's return for that year.

HSA Popularity Booming

Several factors have lead to a boom in the popularity of HSA accounts. First, employers expect the cost of healthcare to rise 8% or more in 2007. In order to keep costs down, companies have increased the amount employees pay for everything, and more companies are now offering high-deductible insurance policies, coupled with tax-free HSA accounts. In 2004, fewer than 10% of mid-size and larger firms offered a high-deductible option, according to benefits consultant Watson Wyatt. In 2007, more than 60% will.

Increased competition is also making Health Savings Accounts a better deal. The website HSA Insider (www.hsainsider.com) listed 66 providers for qualifying high-deductible policies in 2004, 87 in 2005, and more than 100 currently. Most larger health insurance providers (Blue Cross/Blue Shield, Principal, Aetna, Cigna, United, etc.) are now offering these policies and more are following suit daily.

The number of financial institutions (banks, brokerage firms, and mutual fund companies) offering HSA investment accounts is growing at an even more rapid pace. HSA Insider listed 23 financial institutions offering these accounts in 2004, 65 in 2005, and more than 600 currently. Moreover, Bank of America, Key Bank, US Bank, and others recently announced that they are slashing fees and offering more investment options in hopes of winning more HSA accounts. HSA deposits are projected to rise from around $6 billion now to over $65 billion by 2010. To compare options, go to www.hsafinder.com or www.hsainsider.com.

Also driving the HSA boom is projected soaring medical costs for doctors in retirement. According to recent estimates posted at Fidelity.com, a 65-year old doctor is projected to pay at least $6,631 annually in healthcare expenses for deductibles, co-payments, premiums, dental/vision/hearing care, and prescriptions. In retirement, that adds up to over $200,000 per retiree in out-of-pocket costs, not even considering inflation.

Second Retirement Plan

Many doctors are funding HSAs purely as a second retirement plan, without regard to their projected healthcare expenses. These doctors want to take maximum advantage of the tax-deductible contributions of up to $5,650 which can be made into the HSA account annually. In addition, these tax-deductible contribution amounts will increase annually, since they are indexed for inflation. Moreover, doctors want to take advantage of the fact that HSA funds compound tax-free and withdrawals can be accessed at any time.

Tax savvy doctors realize that they are not required to use the HSA for medical bills. There is nothing to stop doctors from allowing the annual contributions (and the earnings thereon) to pile up, while medical expenses are paid for out-of-pocket. Unused HSA funds carry forward each year. At age 65, the doctor can use these funds tax-free to pay for Medicare premiums, co-payments, long-term care insurance, etc. Alternatively, he can withdraw funds from the HSA for non-medical purposes and pay federal and state income taxes on them, but without any penalty.

For example, a doctor age 40 with the maximum family deductible coverage could contribute and deduct $5,650 annually to the HSA account on tax-deductible basis. Assuming an 8.0% return, the funds would grow to $450,760 at age 65.

Moreover, doctors can fund HSAs for employees with bonus or salary increase funds on a tax-favored basis. The contributions kicked into the account on behalf of the employee are tax-deductible and are exempt from federal and state payroll tax purposes. Moreover, these contributions do not count as compensation for retirement plan purposes. From the employee's standpoint, contributions into the HSA are not considered as income for federal or state income or payroll tax purposes. Moreover, amounts contributed grow on a tax-free basis and be accessed tax-free for payment of future medical expenses.

We predict that HSA enrollment by doctors will continue to soar over the next five years. Using these plans will allow doctors to control premium cost increases, while taking advantage of the tremendous tax incentives, expanded investment options, and lower operating costs offered by investment providers.

These plans work extremely well for doctors who are younger, and those in good health, where the out-of-pocket payments are minimal. If you haven't made the jump to an HSA already, now's the time to consider it. It could allow you to accumulate hundreds of thousands of dollars by age 65, available to pay medical or other expenses.

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