A health savings account (HSA) is a tax-favored account set up exclusively to pay certain medical, dental, vision and long-term care expenses of the HSA owner, spouse and dependents. The Federal Employees Health Benefits (FEHB) program offers HSAs to qualifying federal employee and annuitants.
This column discusses the requirements for a federal employee and retiree to own and to contribute to an HSA and the benefits of making withdrawals from one’s HSA to pay qualified medical expenses.
With the recent start of the FEHB program open season and until Dec. 9, 2019, employees and annuitants have an opportunity to enroll in and to contribute to their HSAs starting in January 2020.
There are several prerequisites for an individual to first obtain and then to contribute to an HSA. The most important prerequisite is that the individual must be covered by a high-deductible health plan (HDHP) and the individual is also not covered by another health insurance plan that is not a HDHP. Other prerequisites are discussed below.
An HDHP meets certain requirements regarding minimum deductibles and maximum out-of-pocket expenses. The IRS each year sets the minimum deductibles and maximum out-of-pocket expenses. The following table shows the limits for 2020:
As a general rule, the HDHP may not pay for, or reimburse medical expenses (except for certain preventive care expenses such as annual well visits and preventive care) of the HDHP enrollee and family members until the minimum deductible for the year has been met.
An HSA combines the features of a deductible traditional IRA (contributions are deductible – specifically, an adjustment to one’s income on Form 1040) and a Roth IRA in which earnings and contributions are distributed tax-free provided the distributions are used to pay for qualified medical, dental, vision and long-term care expenses.
Federal Employees and HSAs
The FEHB program offers HDHPs that are associated with HSAs. Some of the HDHPs are offered to employees nationwide while HDHPs are offered to employee who live in certain states. A list of those plans under the letters “HDHP” may be found below:
During the current FEHB program open season, employees and annuitants can enroll in an HDHP. However, the following employees and annuitants are not eligible to participate in an HSA; that is, they cannot contribute to an HSA through their enrollment in a FEHB program sponsored-HDHP:
(1) Employee or annuitants enrolled in any part of Medicare – Parts A, B, C or D;
(2) employees or annuitants enrolled in additional health insurance plans associated with a non-HDHP health insurance, either themselves or through a spouse; and
(3) employees claimed as a dependent on someone else’s federal income tax return. In addition, an employee cannot be enrolled in a health care flexible spending account (HCFSA) while contributing to an HSA.
Note that being enrolled in a “limited expense” health care FSA (“LEX HCFSA”) (that only pays for out-of-pocket dental and vision expenses) (offered through the FSAFEDS program) (www.fsafeds.com) is permitted while contributing to an HSA. Being enrolled in a Federal-sponsored dental or vision insurance program through the Federal Employees Dental and Vision Insurance Program (FEDVIP), or an individually-purchased dental, vision or long-term care insurance plan, will not disqualify an individual from contributing to an HSA.
Unlike the HCFSA in which an employee has to re-enroll each year, an HSA owner does not have to re-enroll each year in the same HDHP in order to keep contributing to his or her HSA. Most importantly, the HSA owner can carry over from year to year any end-of-year balance left in the HSA. Upon retiring from federal service, an employee can keep his or her HSA to pay for out-of-pocket medical, dental, vision and long-term care expenses (including long-term care premiums) throughout retirement.
A federal annuitant can continue to contribute to his or her HSA provided he or she:
(1) Covered by an HDHP; and
(2) is not enrolled in any part of Medicare. However, if an annuitant is not eligible to contribute to the HSA for one reason or other, the annuitant is still eligible to make withdrawals from the HSA. If the withdrawals are made to pay for qualified expenses (medical dental, vision or long-term care), the withdrawals are at least federal income tax-free (some states may HSA withdrawals). On the other hand, if the withdrawals are made for non-qualified expenses, then federal and state income taxes would have to be paid. If the HSA owner is over age 65, then there would be no 20 percent penalty, as there would be if the HSA owner was younger than age 65 and makes HSA withdrawals to pay for non-medical expenses.
An HSA is administered by a trustee or custodian, similar to a traditional or Roth IRA. Upon the death of the HSA owner, a spousal beneficiary inherits the HSA and uses it as his or her own, making tax-free withdrawals to pay for out-of-pocket medical, dental, vision and long-term care expenses until the HSA is depleted. Non-spousal beneficiaries of an HSA (such as children) must withdraw funds from their inherited HSA starting after the death of the HSA owner. They will pay federal and state income taxes on withdrawals but will not be subject to the 20 percent early withdrawal penalty.
Each year the IRS announces limits on contributions and maximum out-of-pocket spending amounts under HDHPs linked to HSAs. The following table summarizes the IRS limits for 2020:
Dependent Children and HSAs
While the FEHB program allows employees to include their adult children (up to age 20) on the FEHB program coverage, the IRS definition of a qualified dependent for the purpose of reimbursing the dependent’s medical, dental or vision expenses under the parent’s HSA is different. In short, the parent would have to be able to claim that child as a legitimate “tax dependent” on the parents’ federal tax return in order to use the HSA for reimbursement of the child’s qualified expenses from the HSA. This is the case even though the Tax Cuts and Jobs Act of 2017 (TCJA – the current tax law in effect through 2025) has eliminated the “dependent exemption” on the federal income tax return. The Internal Revenue Code still maintains rules regarding “tax dependents.”
Steps for federal employees and retirees to take in order to contribute to an HSA during 2020:
Step 1. During the current “open season,” the employee or annuitant enrolls in an HDHP under the FEHB program.
Step 2. The employee’s HDHP establishes an HSA with a fiduciary. Each HDHP has information on how this step works in the HDHP plan brochure.
Step 3. The HDHP automatically contributes a portion of the employee’s FEHB premium into the employee’s HSA, called the “premium pass-through”.
Step 4. The employee can make additional contributions to their HSA up to the IRS’ maximum contributions limit as shown in the table above. Employee HSA contributions are an adjustment to income on one’s Federal income tax return and therefore result in additional current year tax savings.
Step 5. The HDHP provides for the HDHP enrollee and for family members coverage for “preventive” care (including annual check-ups) without having to first reach the deductible (this is called “first dollar” coverage), in accordance with the Affordable Care Act.
Step 6. HDHP enrollees can pay the cost of non-preventive care for the enrollee’s family using withdrawals from the HSA, up to the HDHP deductible amounts. Note that if an HDHP enrollee and/or family member incurs out-of-pocket expenses that reach the HDHP maximum out-of-pocket limit as shown in the table above, the HDHP should then cover the medical expenses at 100 percent. This will likely be the case if the HDHP enrollee uses in-network providers.
Finally, the following is additional information related to HSA participation:
1. IRS Publication 502 (Medical and Dental Expenses) downloadable at www.irs.gov/pub/irs-pdf/p502.pdf, has a list of qualified medical, dental and vision expenses that can be reimbursed tax-free from an HSA.
2. Contributions to the HSA grow tax-free over time (similar to a Roth IRA), assuming that the HSA earnings when withdrawn are used to pay for qualified medical, dental and/or vision expenses.
3. An HSA belongs to the owner, even when the HSA owner leaves or retires from federal service.
4. HSA owners are highly encouraged to shop around for an HSA custodian who will be somewhat aggressive in investing the funds in the HSA, especially if the HSA owner is young. Using some simple assumptions, it is possible to calculate the future value of an HSA during the accumulation phase of an HSA. For example, assuming an investment return of 6 percent and a 25 year old HSA owner who rolls over half of the annual HSA contribution of $3,400 ($1,700) from year-to-year. That is, the $1,700 is not withdrawn to spend on qualified expenses but rolled over from year-to-year, as is allowed from year-to-year. This rollover of funds is done for 40 years until the HSA owner is age 65. At that time, the HSA will be worth approximately $265,000. At that time, the HSA owner can make withdrawals to pay for qualified expenses, including being reimbursed for Medicare Part B premiums and long-term care insurance premiums or to pay long term care expenses.