There is no question that the cost of medical care is increasing. Medical care costs are increasing at a far greater pace annually than the average annual pay increase or retirement cost-of-living allowance (COLA). Federal employees and annuitants have an opportunity to save money tax-free to pay current and future medical expenses by utilizing health savings accounts (HSAs). But to reduce the cost of medical care using HSAs, it is imperative that employees and annuitants have a full understanding of HSA rules. In the first of two columns discussing HSA rules, this column discusses HSA eligibility rules and what types of medical expenses can be paid from an HSA.
HSAs combine the features of deductible traditional IRAs and Roth IRAs for medical expenses. Contributions to HSAs are made with pre-taxed dollars and distributions from HSAs are tax-exempt if used to pay for qualifying medical expenses. Also, like an IRA, HSA funds do not have to be spent in a calendar year and can be carried over in the plan balance indefinitely and spent in retirement.
If an individual is eligible, then he or she can make deductible contributions to an HSA administered by a bank, brokerage, credit union or insurance company. The HSA can be invested in stocks, bonds, mutual funds, ETF’s and similar investments. Earnings grow tax-free provided when they are withdrawn they are used to pay for qualified medical expenses. Federal and state income taxes must be paid if the amount withdrawn is not used to pay for qualified medical expenses, In addition, if the individual is younger than age 65 and HSA withdrawals are made to pay non-medical expenses, a 20 percent early withdrawal penalty must also be paid.
HSA Eligibility Rules
In order to contribute to an HSA, an individual must meet several conditions. These conditions are:
- The individual must be covered by a high deductible health insurance plan (HDHP). For self only coverage, the HDHP must have an annual deductible of at least $1,350 for 2018 and 2019, and annual out-of-pocket expenses (deductibles, copayments, etc.) and other amounts (but not premiums) not exceeding $6,650, or up to $6,750 for 2019. For family coverage, including self and at least two or more eligible family members, and self plus one eligible family member, the HDHP must have an annual deductible of at least $2,700 for 2018 and 2019, and annual out-of-pocket expenses not exceeding $13,300 or up to $13,500 for 2019. Except for preventive care, the HDHP may not pay benefits until the person or the person’s family has incurred annual covered medical expenses in excess of the annual deductible.
- The individual may not be covered by any other health insurance plan that is not a high deductible health insurance plan. This other health insurance plan includes an individual’s secondary health insurance, a spouse’s health plan that is not high deductible, or any part of Medicare (Parts A, B, C or D). The individual may still be covered under workers’ compensation laws, insurance for the individual’s auto and home insurance for a specified disease or illness, dental insurance, vision insurance, long-term care insurance or disability income insurance.
- The individual may not be claimed as a dependent on someone else’s tax return. With the passage of the Tax Cuts and Jobs Act of 2017 (TCJA), this language is complicated for the years 2018 through 2025. This is because under TCJA, there is no deduction for tax dependents during 2018 through 2025. TCJA in essence set the exemption amount to zero for tax years 2018 through 2025. But TCJA did not eliminate tax dependents. Therefore, if an individual can be claimed as a tax dependent on another person’s tax return, that individual is not eligible to contribute to his or her own HSA.
Note that the Affordable are Act of 2010 (ACA) allows adult children up to the age of 26 to be included on their parents’ health insurance plans, regardless if the child is claimed as a tax dependent on the parents’ tax return, or if the child claims the dependent exemption for himself or herself. For an adult child’s medical expenses to qualify for disbursement from the parent’s HSA, the adult child must be a tax dependent. This means that although an adult child may be included on the parents’ health insurance, HSA funds cannot be used to pay that child’s medical expenses unless the child is a tax dependent child. The following example illustrates:
Wendy, age 52, is a Federal employee, enrolled in a FEHB HDHP and contributes to the HSA that is associated with her HDHP. Wendy is divorced and has one child, Phillip, age 23 who is also a Federal employee. To save premium dollars, Wendy has self plus one coverage retaining Phillip on her FEHB HDHP. Since Phillip has too much income, Wendy cannot claim Phillip as a tax dependent. This means that Wendy’s HSA cannot be used to pay for Phillip’s out-of-pocket medical expenses. Phillip should therefore enroll in his own HDHP and have his own HSA to pay for his out-of-pocket medical expenses.
HDHP and Qualified Medical Expenses That Can be Paid Using an HSA
An HDHP has:
- A higher annual deductible than typical fee-for-service plans; and
- A maximum limit on the sum of the annual deductible and out-of-pocket medical expenses that the insured must pay for covered expenses. Out-of-pocket expenses include copayments, coinsurance, deductibles and other amounts, but do not include health insurance premiums.
An HDHP may provide preventive care benefits without a deductible or with a deductible less than the minimum annual deductible when it comes to preventive care. Preventive care includes, but is not limited to, the following types of medical procedures:
1. Periodic health evaluations, including tests and diagnostic procedures ordered in connection with routine examinations, such as annual physicals.
2. Routine prenatal and well-child care.
3. Child and adult immunizations.
4. Tobacco cessation programs.
5. Obesity weight-loss programs.
6. Screening services. This includes screening services for the following:
b. Heart and vascular diseases
c. Infectious diseases
d. Mental health conditions
e. Substance abuse
f. Metabolic, nutritional and endocrine conditions
g. Musculoskeletal disorders
h. Obstetric and gynecological conditions
i. Pediatric conditions
j. Vision and hearing disorders
A federal employee covered by an HDHP and who is also enrolled in a healthcare flexible spending account (HCFSA) or a health reimbursement account (HRA) that pays or reimburses qualified medical expenses generally cannot make contributions to an HSA.
It is important to emphasize that an individual who has a funded HSA can always make withdrawals from the HSA to pay for qualified medical expenses. However, whether the individual can contribute to the HSA in a particular year depends on the three factors discussed above:
- covered by an HDHP;
- not have any other health insurance coverage that is not a HDHP; and
- cannot be claimed as a tax dependent by another individual.
Qualified medical expenses that can be paid using an HSA are those that would be deductible for tax purposes as medical expenses. This includes amounts paid for: (1) copayments or coinsurance; (2) deductibles; (3) diagnostic services; (4) long-term care insurance premiums; (5) LASIK surgery; (6) some nursing services; (7) medicines and drugs if they require a prescription; and (8) insulin, even without a prescription. HSA distributions can also be used to pay COBRA health care continuing coverage, Medicare Parts B and D monthly premiums.
Coordination with Medicare
Once particular area of HSA planning in which mistakes are made with HSAs is when an individual becomes eligible for Medicare. As noted earlier after an individual becomes eligible for Medicare, the individual can no longer contribute to an HSA. This is because Medicare is not considered a high deductible health plan. Note Medicare Part A (hospital insurance) is automatic and premium-free once an individual becomes age 65 and begins receiving Social Security retirement benefits. This is even if Medicare Part B (medical insurance) is declined for one reason or another.
If Social Security benefits begin before age 65; for example, in the case of Social Security disability benefits, then Medicare Part A is not triggered because it is only applicable for those individuals age 65 and older. Contributions to an HSA would still therefore be allowed.
An individual may continue to make HSA contributions with respect to the months of the year before he or she becomes ineligible and can enroll in Medicare. If an individual does make contributions to his or her HSA after enrolling in Medicare, then the excess contributions must be withdrawn. This also holds true if the individual enrolls in Social Security and Medicare Part A at age 65.This rule applies to periods of retroactive Medicare coverage, meaning that if an individual delayed applying for Medicare and upon enrolling, the enrollment is backdated, then any contributions made to the individual’s HSA during the period of retroactive coverage are considered excess and must be withdrawn.