The information in this FAQ page is believed to be accurate but is not warranted. It is provided to assist employers, employees and individuals in understanding many of the details of HSA medical plans and the accompanying bank accounts. It is not our intention to provide tax or legal advice; please consult your accountant or tax advisor with questions concerning your specific situation.

We welcome your questions if you do not see it covered here.

• GENERAL HEALTH INSURANCE QUESTIONS
  
• CONTRIBUTIONS (DEPOSITS) INTO HSA ACCOUNTS
• DISTRIBUTIONS (WITHDRAWALS) FROM HSA ACCOUNTS
• CATCH-UP CONTRIBUTIONS AND ELIGIBILITY FOR MEDICARE
• TAX-RELATED QUESTIONS
• ESTABLISHING THE HSA BANK ACCOUNT AND BANK FEES

GENERAL HEALTH INSURANCE QUESTIONS

Q. If an employee’s spouse is an independent contractor and purchases health insurance, is it OK to have our employee take insurance with his/her spouse instead of the our employer-sponsored insurance?
A. Yes, since your employee can elect to obtain coverage either through the employer-sponsored plan or his/her spouse. If he/she elects coverage through the spouse, then that employee is still considered to have medical coverage under Vermont’s 75% participation rule.

Q. I am an employee of a company that offers a health plan that is very rich and thus very expensive (employees have to pay 50% of the monthly premium through payroll deductions). Can I obtain my own health coverage instead of having to remain on my employer’s plan?
A. I have fielded this question many times. Unfortunately, the Vermont statutes do not permit employees to obtain individual coverage except for somewhat unique situations. Under this law if an employer offers a group medical insurance program for which the employee is eligible (meaning he/she is a permanent employee, works a sufficient number of hours per week and has satisfied any probationary or waiting period) then that employee is not able to purchase his/her own individual policy. If you are also self-employed, you declare the self-employment income on your federal tax return and your self-employment income is at least equal to the annual premium of the coverage you intend to purchase, then you may be eligible to purchase a group policy (where the rates are generally better than for non-group/individual policies in Vermont).

One other suggestion might be for your employer to offer two medical plans rather than just the one now being offered. Most Vermont health insurance carriers permit employers with at least 6 employees covered under the medical plan to provide two plans (a dual option). Many employers elect to have the dual option to improve morale among employees (since one health plan often does not suit all participants) and to boost enrollment to satisfy the Vermont 75% participation requirement.

Another idea to help make the employee’s share of insurance premiums more affordable is to ask the owners to consider introducing a simple flexible benefit plan (also called a premium only plan or POP) to enable employees’ premium contributions to be made in pre-tax dollars – exempt from federal and thus Vermont income taxes as well as Social Security and Medicare taxes. This could mean a savings of between 25% and 35% depending on your taxable income.

Q. If an employee initially declined health coverage under the employer-sponsored plan because he/she had coverage through the spouse working for a different employer, can that employee pick up our coverage during the plan year as a result of loss of current coverage because the spouse is losing his/her job or experiencing a reduction in hours?
A. Yes. Loss of other health insurance coverage either through the spouse losing his/her job or exper-iencing a reduction in hours that would cause this spouse to lose eligibility are considered life events. Most if not all carriers will permit your employee and his/her family to enroll in the employer-sponsored medical plan without having to wait until the next open enrollment period, providing your employee can provide proof of the loss of coverage and enrolls within the 30 days immediately following the date of the event that caused the family to lose health coverage.

Q. We just learned that I am pregnant with the baby, due in seven months. We currently have two-person health coverage through my employer. Do we have to sign up for family coverage before our child is born? Also we are on a $1,000 deductible HMO plan; will we have to pay one or two deductibles?
A. No, you can remain on two-person coverage until the baby is born. Insurance companies allow couples to enroll their newborns within thirty days of delivery, with the first 30 days automatically covered. If the birth is a normal vaginal delivery with no complications for mother or infant, then most carriers will charge only one deductible and not two. If the baby does have to stay in the hospital longer than the mother, then you will most likely be billed for two deductibles or in your case $2,000.

Q. After the deductible is reached (and any co-insurance level, if applicable, has been satisfied) to the point where claims are then covered at 100% by the medical plan for the balance of the calendar year, is it possible that out-of-network doctors would “balance bill” for charges above the carrier’s reasonable and customary amount?
A. Yes. The providers not participating in the plan’s medical network can still balance-bill the patient for charges in excess of the Reasonable and Customary Allowance (R & C) applied by a carrier, even though the calendar year deductible (and any co-insurance, if applicable) has been reached and the plan is paying 100% of the covered claims. A medical plan that features a preferred provider network will generally pay up to the carrier’s R & C Allowance while the patient is responsible for charges in excess of this R & C. Balanced billed amounts are an eligible expense payable from HSA account under HSA medical plans..

Furthermore, as you are accumulating charges that are applied toward your deductible resulting from visits to a non-participating provider (not in the carrier’s network), that carrier will only credit the amount of the covered charges up to the R & C Allowance toward the deductible, even though the patient may be charged a higher amount.

Q. What constitutes a high deductible health plan that qualifies as an approved HSA medical plan?
A. According to the 2003 legislation that created tax-favored HSA bank accounts, a qualified high deductible health plan (HDHP) for 2007 must have a single calendar year deductible of no less than $1,100 (minimum of $2,200 for two-person or family coverage) and a total out-of-pocket (the combined total of the deductible and any co-insurance amounts) no greater than $5,500 for single coverage ($11,000 for two-person/family level of coverage). Co-insurance, as the name implies, is a threshold of health insurance coverage at which the plan pays a portion of covered services and the insured pays the balance such as 80%/20%, after the deductible has been satisfied. Medical plans are permitted to have higher out-of-pocket costs (deductibles and co-insurance) when seeing out-of-network providers. In addition, a qualified HDHP is prevented from having co-payments for physician office visits, except for preventive care or routine physical visits, as well as for prescription drugs. Charges incurred for these two items must be applied toward the plan’s annual deductible at least until the deductible is met. Any type of medical plan can qualify as a HDHP including a PPO (preferred provider organization), HMO, POS (point of service), OAP (open access plan) and even a self-funded medical plan.

Preventive care services are considered a “safe harbor” that can be covered with a co-payment, co-insurance or covered 100% by the health plan. Preventive care can include physicals, female well-care and infant and well-child visits, immunizations, Pap and PSA tests, mammograms screenings and baseline colonoscopies. Participants covered by an HSA-qualified plan cannot be covered by a second comprehensive medical plan unless that second plan is also a qualified HDHP, however you are allowed to be covered by an accident policy, specific disease or illness plan, a drug discount card or wellness program.

Q. What is an “embedded” or “stacked” deductible on an HSA medical plan?
A. An embedded or stacked deductible is a feature that some HSA-qualified medical plans offer participants electing two-person or family coverage. With this feature, when one family member has covered medical claims that reach the plan’s single deductible, then all future covered claims for the balance of the calendar year are covered at either 100% (if your plan has no co-insurance level) or you immediately begin paying at the co-insurance level (such as 20% of additional claims). Unlike plans that don’t offer this feature, this family member does not have to incur covered claims up to the family deductible before the carrier begins paying benefits. Health plans with the embedded deductible generally have slightly higher two-person and family premiums to offset the added potential exposure to the insurance company.
An example would be an HSA plan that includes the embedded deductible with a $2,250 single deductible and a $4,500 family deductible after which additional claims are paid at 100% for the balance of the calendar year. If a family member should satisfy the $2,250 single or individual deductible during the year, then additional covered claims for that individual will be paid 100% by the carrier for the balance of the calendar year. With the arrival of January 1st, the individual or family deductibles revert back to zero. For the plan that does not have this embedded feature, the cumulative claims for this patient and other family members would have to reach $4,500 during the year, before the plan starts paying claims at 100%.

Q. May domestic partners be named on the HSA Account if they are covered under the plan?
A. No. Only one person, the individual through whom the insurance coverage was obtained, can be named on the HSA account. This is true for both heterosexual and homosexual couples. However, Domestic Partners (DP) or Civil Union (CU) partners can be named as a co-signer or Power of Attorney (POA) on the principal accountholder’s HSA account. As power of attorney, the DP/CU has access to the funds to pay the claims of the principal accountholder, the person who took out the HSA-qualified medical plan and his/her immediate family members that would qualify as a legal “dependent” of the accountholder as defined by the IRS on his/her federal tax return.

The accountholder can also name his/her DP or CU partner can also be named as the beneficiary. The DP/CU can make contributions into the HSA account, but will not receive any tax benefit for doing so.

CONTRIBUTIONS (DEPOSITS) INTO HSA ACCOUNTS

Q. My spouse is self-employed and has single coverage under an HSA plan while I am enrolled in an HSA medical plan with two-person coverage (my son and myself) with my employer. Both parents are over 55 years of age. How much can we contribute to our respective HSA accounts.
A. This is somewhat of a unique situation but with the continued popularity of HSA’s is likely to come up more often. For 2007 the self-employed spouse (but he/she could just as easily work for an employer) is able to contribute up to $2,850 for the single coverage plus up to $800 as a catch-up contribution for a total of $3,650. You are able to contribute up to $5,650 with your two-person coverage plus up to another $800 catch-up deposit for a total of $6,450 for 2007. In both cases this assumes that you continue to be enrolled in your respective plans at the same level of coverage for the entire calendar year. Your situation is probably the most opportune from a standpoint of potentially sheltering the maximum amount of your earnings into an HSA account.

Q. One of our employees has opted to go off our HSA insurance policy and onto her husband’s medical plan, which is not a high-deductible HSA-qualified plan. Is she still able to continue to make personal contributions to her HSA?
A. When an accountholder is no longer covered by an HSA-qualified medical plan, he/she are no longer permitted to add money to his/her HSA bank account and neither is the employer able to continue making contributions to that employee’s account. Secondly, the IRS requires an accountholder to prorate the maximum contribution based on number of full months he/she was covered by the HSA medical plan. The IRS will assess a 6% penalty for over-contributing in a tax year and requires the excess amount be withdrawn and included in the taxpayer’s taxable income for that year.

For example, if your employee went off the employer-sponsored HSA plan as of September 1st, and is not covered by another HSA-qualified plan, then he/she is permitted to deposit up to 8/12th of the statutory limit for 2007 from all sources (covering the months of January through August), regardless of the size of the health plan deductible. Assuming your employee had single coverage for all of these 8 months, the statutory limit for this year is $2,850 and 8/12th of this amount would be $1,900.00. Furthermore, if this employee is 55 or older while covered by the HSA medical plan, he/she would be able to deposit an additional $533.33 (the maximum catch-up contribution for 2007of $800.00 times 8/12th) for a prorated grand total of up to $2,433.33.

A corollary situation that might occur would be an employee with two-person or family level of coverage dropping back to single coverage as the result of a divorce or the spouse electing health coverage under a new employer. In this instance, the maximum contribution must be adjusted based on the number of full months with two-person or family coverage and the number of months under single coverage.

You will want to make sure the company is not depositing additional contributions into his/her account as of the date s/he left the HSA plan. If payroll or if the employee accidentally made a contribution after having been dropped from the HSA plan, a special form needs to be obtained from the bank that is handling the account that permits a withdrawal without having to incur the 10% penalty for an ineligible distribution.

Q. How are the contributions of business owners treated by the IRS?
A. For a partner, sole proprietor, LLC and S corporation owner and self-employed accountholder, the IRS considers the contributions you make to your personal HSA account to be treated as an adjustment to your gross personal income after business expenses have been netted out (to be entered on the bottom of the front page of the federal 1040) and not as a business expense. The principal difference is that these HSA contributions are still subject to Social Security and Medicare taxes. Conversely, contributions made by a C corporation are treated as a business expense by the corporation.

DISTRIBUTIONS (WITHDRAWALS) FROM HSA ACCOUNTS

Q. On your Benefit Design and Strategies web site you make reference to IRS Publication 502 (and even provide a link) and suggest that this is the authoritative source for determining which medical expenses are eligible to be paid out of one’s HSA account, but with one glaring omission – over-the-counter medications. Please explain why the IRS does not include a listing for these items?
A. The most current edition of IRS Publication 502 will not specify that Over-the-Counter (OTC) drugs are a qualified medical expense. The OTC withdrawal allowances are permitted for Flexible Spending Accounts (FSA) and HSAs, but are not an allowable expense to be deducted of Schedule A “Itemized Deductions” of the federal 1040 tax return, for which this publication was specifically written to assist taxpayers. The IRS promulgated a ruling on September 3, 2003 (ruling 2003 – 102) making the cost of over-the-counter medicines and remedies eligible for payment out of one’s HSA or FSA account, but not permitted to be itemized on Schedule A of the 1040.

To be eligible for HSA’s and FSA’s, the item(s) must be purchased to alleviate or treat a personal injury or sickness and cannot be intended for cosmetic use (such as a skin cream) or merely beneficial for good health (multi-vitamins or sun screen). Furthermore, a doctor’s prescription or recommendation is not required, but a written note from your doctor may be considered if the product or treatment is borderline cosmetic or for general health.

Q. What happens if I withdrawal funds from my HSA account and use them for an ineligible expense, such as for car repairs or a big screen TV?
A. If a taxpayer and HSA accountholder under the age of 65 uses funds from their HSA account for ineligible purposes, he/she will be assessed a penalty of 10% of the amount of the funds inappropriately withdrawn plus he/she will have to add the withdrawn amount to taxable income in the year the money was taken out. Bottom line, this could mean that for every dollar distributed (withdrawn) for an ineligible purpose, between 25% to 30%, should be set aside to cover the penalty and additional income taxes due at the time of filing your tax return. In addition, there could be interest charged on the taxes and penalty due that should have been collected if not reported in the year the inappropriate distribution occurred. For all these reasons, making ineligible withdrawals is discouraged.

For participants aged 65 and older, they can withdraw funds from their HSA account for any purpose without being subject to the 10% penalty, but they must add any “medically ineligible” withdrawal(s) to their income for tax purposes in the year the withdrawal(s) were made. Of course, if withdrawals are to pay for qualified medical and medically-related expenses, these distributions are tax-exempt just as they are for accountholders under age 65.

Q. Can I use the funds in my HSA account to pay for the medical expenses of my family members even if they are on a different medical plan that is not HSA-qualified?
A. Yes. When I first saw this provision in the HSA rules, I had to read it several times to make sure I was comprehending correctly. The medical claims and medically-related expenses of immediate family members (i.e. spouses, children, step-children, adult children that qualify as full-time students and thus financially dependent upon the parent(s), and any other person that satisfies the definition of a “dependent” under IRS personal tax return regulations) that are not eligible for reimbursement from another insurance policy or a flexible spending account (FSA) can be paid for or reimbursed from your HSA account. This is true even if your other eligible family members are covered by another health plan, including a state-sponsored plan that does not qualify as a high deductible health (i.e. HSA) plan.

Q. Can I pay for qualified medical expenses incurred in the current year with contributions I make next year?
A. Yes. An account accountholder or his/her power of attorney may defer to later taxable years distributions (withdrawals) from the HSA bank accounts to pay for or reimburse qualified medical expenses incurred in the current year as long as the expenses were incurred after the HSA account was established. Similarly, a distribution [withdrawal] from an HSA account in the current year can be used to pay or reimburse expenses incurred in any prior year as long as the expenses were incurred after the HSA account was established. Thus there is no time limit on when the distribution must occur. However, to be excludable from the account beneficiary’s gross income, he or she must keep records sufficient to later show that the distributions [withdrawals] were exclusively to pay for or reimburse qualified medical expenses, that the qualified medical expenses have not been previously paid or reimbursed from another source and that the medical expenses have not been taken as an itemized deduction under Schedule in any prior taxable year.

Q. I have recently become covered under an HSA-qualified medical plan and have opened my HSA bank account. Can I pay medical bills from this account for services that were provided prior to the start of my HSA plan?
A. No. The IRS does not permit medical expenses that were incurred prior to both the effective date of the HSA medical plan and the opening of the bank account. Thus, your prior bills for medical services are not eligible to be paid for out of your HSA account.

Q. My HSA medical plan commenced in January of this year but I did not open my HSA account until June. In the intervening time period, I incurred medical bills, most of which were credited toward my deductible. Since I was covered by an HSA- qualified medical plan, can I pay for these eligible expenses out of my HSA account?
A. Unfortunately, no. In January, 2005, the IRS issued new regulations that require the HSA bank account to be opened in addition to having the HSA medical plan in effect before medical expenses can begin being paid or reimbursed. Any claims or receipts that predate the opening of the bank account are not eligible to be paid or reimbursed from your account.

Q. Can an accountholder pay the medical claims and/or other medical expenses of his/her domestic partner from the HSA Account if this domestic partner is covered under the plan?
A. Again the answer is unfortunately, no. Vermont permits a subscriber to enroll his or her domestic partner (either same sex or opposite sex) and requires carriers to accept a Civil Union partner onto an employer-sponsored medical plan. However, the federal government does not recognize a domestic partner (D.P.) or Civil Union relationship as a tax-filing unit (unlike a husband and wife). Therefore, while the partner may be covered by the high deductible health plan (i.e. HSA plan), HSA distributions (withdrawals) to pay for the partners medical expenses are considered by the IRS to be an ineligible transaction and thus a taxable event for the accountholder, subject to the 10% penalty and added to taxable income in the year withdrawn.

Q. Are the expenses related to attending Weight Watchers sessions and programs an eligible expense that can be paid for out of one’s HSA account?
A. In a ruling the IRS issued on September 30, 2003 (2003 – 0202), the cost of weight-reducing programs and exercise equipment for home use are an eligible expense that can be paid for out of one's HSA Account if, and only if, the participant's physician has declared the taxpayer's obesity to be health or life threatening or medically necessary. Generally, health club dues are not an eligible expense.

To quote from an IRS Information Letter dated September 30, 2003 (Letter # 2002 - 0202) ... " Because the medical community recognizes obesity as a disease, the IRS already has ruled that participation in a weight-loss program as treatment for physician-diagnosed obesity is a deductible [and therefore an eligible expense to be paid for our of one's HSA account] medical expense. The specifics of what constitutes a weight-loss program are left to the individual's physician."

On a related matter, the IRS addresses the question of the deductibility [and therefore the eligibility of payment from an HSA account] of expenses related to home exercise equipment. "Accordingly, taxpayers [and therefore HSA participants] may deduct [and therefore may pay out of their HSA Account] the cost of equipment for use at home, if required to treat an illness, including obesity, diagnosed by a physician. For an exercise expense [and weight reduction programs] to be deductible [and therefore also an eligible HSA expense] the taxpayer must establish that the expense's purpose is to treat a disease rather than to promote general health, and that the taxpayer would not have paid the expense but for this purpose."

I would suggest a participant wishing to claim the expense of a weight-loss program against their HSA account obtain a written letter from his/her physician and keep this document with the receipts for the weight-loss program.


CATCH-UP CONTRIBUTIONS AND ELIGIBILITY FOR MEDICARE

Q. We recently enrolled in an HSA-qualified medical plan. Since both my husband and I are over 55, are we each eligible to contribute the extra “catch-up” contribution ($800 for 2007) to my new HSA account?
A. No. The IRS does not allow both spouses, each of whom are over age 55 to contribute an extra “catch-up” amount in excess of the “statutory limits” to the same HSA bank account. As the employee, you are considered the primary accountholder, so you can deposit up to an additional $800 for 2007 into your account without penalty. Were your husband to do the same by depositing his extra $800 into this HSA account, the excess amount would be assessed a 6% penalty for over contributing and you would have to add that extra amount to your taxable income on your 2007 tax return.

In order for your husband to also deposit his own “catch-up” contribution for being 55 years of age or older, he would have to have his own HSA plan with single coverage and then open his own HSA account in his name. The disadvantage to having separate medical plans is that the two-person level of coverage is often discounted so that the monthly premium is slightly less than twice the single coverage. The same holds true for the family coverage when compared again to the single plan. On the other hand by having two single plans, you may reduce your exposure by cutting your deductible in half, unless you are on a plan that already has what is called an “embedded” or “stacked” deductible”. (see explanation above)
Also as of January 1, 2007, Congress has done away with the complicated prorating of the catch-up contribution in the year you turn 55. Your 55th birthday could be on December 31st and you would still be eligible to make a full catch-up contribution. However, the IRS still requires taxpayers to prorate a catch-up contribution should you discontinue your HSA-qualified plan before the end of a calendar year, just as they require for the basic statutory-limits contribution.
By the way, the amount of the catch-up contribution is increasing each year until reaching the maximum of $1,000 per accountholder in 2009. These amounts are in addition to the statutory limits described above. The catch-up contribution limits for those 55 and older are as follows:

Q. What happens to my HSA medical plan and HSA bank account when I turn 65 and am eligible for Medicare?
A. There are several possible scenarios here, so let me take one at a time. First, if you continue working beyond your 65th birthday such that you are still eligible for your employer-sponsored HSA medical plan, you could continue on this plan and hold off enrolling in Medicare until you retire. In this case, you can continue making contributions to your HSA account up to the statutory limits plus the catch-up contributions (discussed above). You will want to examine the coverages and cost of each medical plan taking into consideration your employer’s contributions toward the monthly premium and into the HSA bank account, the cost of any supplemental insurance to Medicare beyond parts A and B you may choose to purchase and more recently part D for prescriptions, and whether your employer offers a “buyout” or monetary incentive for getting off your company’s medical plan. To study up on Medicare coverages and supplemental plans, I would suggest that you pick up the latest edition of the U. S. Department of Health and Human Services publication entitled “Medicare and You” at the local Social Security office or download it from the web

If you elect to enroll in Medicare when you become eligible (usually when you turn 65), you can keep your HSA (or similar) medical plan as additional and perhaps duplicate coverage to Medicare, however you are no longer permitted to make contributions into your HSA bank account. This is because the HSA rules prohibit an accountholder from being covered by two comprehensive health insurance policies. You can still access the funds in your account to pay for medical and medically-related expenses on a tax-free basis; in fact, at age 65 you can begin taking money for none-medical purposes without being assessed the 10% penalty, however if you use the funds to pay for ineligible services or products, you must claim those amounts as taxable income on your federal return.

If you currently have two-person or family coverage, the carrier will likely have you enroll in an individual policy with coverages similar or the same as your HSA medical plan, while your spouse and/or family will continue to be covered by the HSA plan. Your spouse, then will be able to open his/her own HSA account and continue to make contributions, including the catch-up contributions, if he/she is 55 or older.

Once you have picked up Medicare, it is often not advantageous to continue on the high deductible HSA plan, unless someone else is paying most of the premium. A supplemental policy to Medicare together with a prescription drug rider (Part D) might better suit your needs. You never forfeit the savings in your HSA account. You are still able to use the funds tax-free to pay out-of-pocket health expenses not covered by these other policies, as well as for dental expenses, vision exams, corrective eyewear, hearing tests and hearing aids including batteries, many homeopathic medical services, over-the-counter medications and even a large percentage of the premiums on long-term care insurance policies. The IRS does not allow you to pay the premiums for Medicare Part B or these supplemental policies from your HSA account.

TAX-RELATED QUESTIONS

Q. Are contributions that I make to my HSA tax deductible?
A. Contributions you make to your HSA in after-tax dollars are considered an “adjustment to income” to be entered in the bottom section of the front page of your federal 1040 tax return. As an employee, these deposits are exempt from federal and state income taxes but not from SS and Medicare taxes, so long as the money remains in your HSA custodial account or you use the funds to pay for or reimburse medical and medically-related expenses. You have up until April 15th (actually more like April 10th or 12th to allow for mail and processing time) to make last minute contributions credited for the prior year. It is important that you indicate on your deposit slip(s) that these retroactive contributions made after December 31st are intended for the prior year. As you prepare your federal return you will want to remember to include these added contributions, since the 1099SA statement issued in January from your bank will not reflect these additional amounts.

Q. If an employer contributes money into each participating employees’ HSA account, does the employee ever pay taxes on these employer contributions?
A. No, with one exception. Employer contributions into employees’ HSA accounts are tax-exempt, not subject to federal or state income taxes or FICA/Medicare taxes. However, if an employee were to withdrawn funds for a non-medical purpose (an ineligible expense), he/she would be subject to a 10% penalty and would have to add that amount to his/her/their income in the year withdrawn. In such a situation, the employer assumes no liability for the misuse of HSA funds of an employee.

Q. Please refresh my memory on what kind of reporting is required from us as the employer to the IRS (W-2s and/or other documents)?
A. If the employer has contributed money to participating employees’ HSA accounts, these contributions must be reported to the IRS. However there should be no tax implications resulting from these employer contributions as long as they were contributed in a comparable (equitable) manner. Such deposits are treated as a business expense for employees (see above for tax treatment for business owners). The total contributions made during the calendar year should be indicated on line 12a of the employee’s W-2 “Wage and Tax Statement” with the amount preceded by the letter “W” (such as W $1,200.00). In addition, if the employer has a flexible benefit plan that includes the option of allowing employees to make their HSA contributions entirely in pre-tax dollars, these redirected payroll deposits are also to be included on line 12a with the same “W” identifier. Employee contributions made with post-tax dollars are not reflected on the W-2 form; the employee will enter these on his/her personal return on Form 8889, “Health Savings Accounts (HSAs)”.

Q. What must the employee file as a part his/her federal tax return?
A. For the employee, he/she must file the IRS 1040 long form (as of the 2006 tax year, the EZ and 1040 A Short Form cannot be used) and an additional one-page Form 8889 entitled “Health Savings Accounts (HSAs)” that instructs the taxpayer to transfer information provided by the administrator or bank found on Form 1099-SA generated at the end of January (similar to a 1099-INT form) that indicates total distributions (withdrawals) made during the prior calendar year and the balance in the account as of December 31st. In addition, accountholders must include personal contributions to their HSA accounts (post-tax dollars) and employer contributions indicated on their W-2 form. The 8889 form also asks if there are any distributions made during the prior year that were for ineligible expenses and therefore treated as taxable income subject to the 10% penalty (for taxpayers is under 65).

In May of each year that the account is active, HSA accountholders will receive a second report from their administrator or bank (Form 5489-SA) that includes total contributions made into one’s HSA account in the preceding year, contributions made between January 1st and April 15th of the subsequent year but applied toward the prior year and the fair market value of the account as of the end of the prior calendar year. All of these reports should be checked for accuracy, especially those contributions made during the three and a half months following the calendar year but intended to be applied to the prior year.

Q. How long should I retain records (receipts, deposit slips, account statements, cancelled checks or carbon copies of checks, check registers, 1099-SA and other bank accountings) that verify the activity in my HSA bank account?
A. The IRS says you should retain these records, broken down by tax year, for at least five (5) years. If you were ever to be audited, even for a different reason, the IRS would likely want to see evidence of the activity in your HSA account.

Q. Here’s a unique situation. I’m a tax preparer and a client of mine over-contributed into his HSA bank account last year and then withdrew virtually all the funds to pay medical bills (he kept enough in to keep the account open). I’m in the process of preparing his federal tax return for last year. Now that I have discovered the error, I am trying to help him avoid having to pay the 10% penalty, as it was an innocent mistake. Is there a way to correct this error and avoid the penalty?
A. The only answer I can come up is to have your client make an early contribution toward this current year and then have him/her withdraw an amount equal to the over-contribution in the prior year using a special bank form that allows an accountholder to withdraw excess funds without penalty. The amount distributed to avoid the IRS penalty must be included with the taxpayer’s taxable income for the tax year you are working on.

ESTABLISHING THE HSA BANK ACCOUNT AND BANK FEES

Q. Why do Vermont (and out-of-state) banks charge monthly service fees that are higher than a regular checking or savings account?
A. I can partially answer the question by saying that these are custodial savings accounts with check-writing and/or debit card privileges. First of all, I have found the service fees among Vermont banks can range of $3.50 to as high as $8.00 per month. Several banks will waive the monthly service fees if your account has an average balance of over $1,000 each month. Bank fees are an eligible HSA expense.

The bank or credit union must initially be approved to administer these HSA accounts by the I.R.S. Like a regular checking or savings account, monthly statements are issued and in most cases available on-line as well. Also, these accounts are required to be interest-bearing, with the interest rate varying by institution. I’ve seen a range recently from 1% to 4% depending on the bank and the size of the account balance.

Then there are additional reporting requirements to the IRS that are not required of regular savings accounts. These include producing a SA-1099 form during the month of January for the prior calendar year that reports the ending balance and the amount of total distributions (withdrawals) from the account during the prior calendar year. In addition, if the accountholder made additional contributions during the first three and half months of this subsequent year but credited for the prior year, an additional updated Form 5489-SA must be issued shortly after April 15th. Furthermore, the institution is subject to audits by the IRS to ensure their reporting is accurate.

Finally, some banks offer added customer service features such as toll-free customer service lines and web support that may include assistance with determining if an expense qualifies to be paid for out of one’s HSA account.

In short, it pays to shop around to locate the HSA-approved banking institution that will handle your account under the most favorable terms; this is true for individuals as well as a Vermont employer if it is coordinating the establishment of individual accounts for its participating employees.

Q. How can I avoid these irritating monthly service fees?
A. Many Vermont banks have policies that will waive or drastically reduce these monthly fees under one of several conditions:


While on the subject, I have also found many banks charge a one-time set-up fee for each new HSA account. Once again, you or your employer may wish to shop around to find the most competitive fees and interest rates.

Q. Are there overdraft charges if I write a check and there are insufficient funds in my account?
A. Yes. Just like any other draft account, the banking institution will charge overdraft charges, and some of them can be large, $20.00 to perhaps $30.00 for each returned check. I personally have found that I need to deposit funds into my HSA account about a week in advance of when I intend to pay medical claims if my account is low, because the deposits, especially made to an out-of-state bank can be slow to be credited. Often your provider is local and the business manager is making deposits of payments for services daily. If the provider is participating in the carrier’s medical network, the subscriber should request the provider bill the carrier directly, so that the carrier’s negotiated discount can be applied. Billing the carrier directly is often one of the requirements participating providers agree to when joining the health plan’s medical network.

Q. If my balance in my HSA account falls to $0 will the account be automatically closed?
A. This depends on the policy of the individual bank or credit union. Generally speaking, a bank will not close an account automatically. Usually, the institution will notify the accountholder in writing of the zero balance and/or an inactive account prior to closing the account, since the accountholder would have to go through the whole process to open a new custodial account.

If the accountholder wants to close out the account, he/she would be asked to do so in writing. If the account has a balance and the instructions did not indicate the remaining funds be rolled over to another HSA account (say with a new employer), then the final distribution would be subject to a 10% penalty (no penalty would be assessed if the accountholder is 65 years or older) and be treated as taxable as income in the year the account were closed.

Q. Is there a charge for the debit card, using the debit card or having the debit card replaced?
A. Again this will depend on the individual policy of each institution. Often, there is no charge for the first debit card. Additional debit cards for a spouse or an out-of-town college student, may cost a modest fee for each additional card. Most banks will charge a fee for replacing a lost debit card. I have heard of banks that charge a fee for each transaction, however this practice seems to be disappearing as HSA plans have become more popular.

Q. What do I need to do to establish an investment account?
A. When an accountholder wishes to open up an investment account, he/she should fist contact the bank handling his/her HSA savings account to determine if it has an investment division. If yes, request an application to open an investment account. If no, you may experience difficulty locating a brokerage house or investment firm that has been approved to administer HSA investment accounts. The investment brokerage community has generally been slow to realize that many of these special accounts are accumulating significant balances, especially with the recent rules permitting accountholders to make larger contributions, often in excess of the calendar year deductibles of many of these HSA-qualified medical plans. If you are having difficulty locating a firm to handle an investment account, you may want to look for another HSA-qualified bank that also offers investment opportunities.

Often there are minimum initial deposits to open such an account and a minimum balance to keep the account active. When establishing an investment, make sure to instruct your bank to prepare a check payable directly to the investment brokerage house rather than to your name to ensure the transferred funds remain protected from federal and state income taxes (if your state’s income taxes piggy-back of the federal program).

Just like any brokerage service, you have access to all of the mutual funds available (excepting closed funds) as well as individual stocks and bonds to invest in. Of course, investing in mutual funds or equities is a risk/reward proposition; the opportunity to realize a higher return on one’s invested amount when compared with a bank, but the risk of experiencing a downturn in the market or a segment of the market resulting in a loss of value below your initial investment. Because this is a tax sheltered account, you are not required to report any capital gains or losses on your federal tax return. Consult your accountant or tax advisor for more information.

And, of course, with a separate custodial account there will be separate monthly or annual account fees, similar to self-directed IRA accounts. Finally, the prudent investor will still retain funds in his/her HSA savings account for medical or medically-related emergency services. Ordinarily, when investing in equities, whether in the form of individual stocks or equity-dominated mutual funds, you should consider holding these assets as a long-term investment. If the market value of your investments took a downturn, it may be advisable to pay for medical services out of personal savings and wait until a later time (even a later year) when the market rebounds to sell shares and get reimbursed.

If an accountholder needed to liquidate some investment assets because an insufficient amount remains in your HSA savings account to cover all the medical bills, you can either call a toll-free line or go on-line to execute a trade to sell a portion or all of a mutual fund or equity holdings in your investment account. You should instruct the broker to deposit the proceeds after commission (if applicable) into your HSA account where you can access the funds.


We welcome your questions concerning Health Savings Accounts medical plans and the accompanying HSA accounts.