Health savings accounts, which were established in 2003 to allow individuals and families to save money from their paychecks in tax-deferred accounts, have been touted as a great way to save for medical expenses both today and in retirement. Despite an enormous growth in the HSA market over the past few years, these popular accounts are facing some regulatory headwinds.
By the end of 2015, more than 16 million HSA accounts had been established, up 22% from 2014, according to the 2015 Year-End Devenir HSA market survey. HSA assets topped $30 billion dollars in 2015, up 25% from the previous year. Devenir projects that by the end of 2018, the HSA market will likely exceed $50 billion in assets covering almost 30 million accounts.
Earlier this summer, the Internal Revenue Service announced new HSA contribution limits for 2017. Individuals will be allowed to contribute a maximum $3,400 to an HSA in 2017, a mere $50 more than this year. The maximum contribution for family coverage next year of $6,750 is unchanged from 2016.
That's the good news.
The bad news affects people who purchase their health insurance through their state or federal health insurance exchanges. New rules will make it virtually impossible for anyone to find an HSA-compatible plan on the government exchanges starting next year. So far, more than 2.8 million people have purchased HSA-compatible plans through the government exchanges, according to Kevin McKechnie, executive director of the American Bankers Association HSA Council.
HSAs offer a triple tax break. Contributions are made with pre-tax dollars, while assets grow tax-free and distributions are tax-free if used for qualified medical expenses. Unlike more familiar flexible spending accounts, HSAs have no “use it or lose it” provision. Unused funds can be rolled over from year to year and accounts are portable, so they can move with an employee from job to job.
But if money is withdrawn from an HSA to pay for anything other than qualified medical expenses, the price is high. Income taxes are owed on the entire withdrawal plus a 20% penalty. Once an HSA account owner turns 65, HSA funds can be spent on anything penalty-free but taxes will still apply if the money is spent on anything other than qualified medical expenses.
A recent study published in the Journal of Financial Planning suggested that the tax savings on an employee's contribution to a health savings account could trump the wealth-building potential of a similar contribution to a 401(k) — even if that includes an employer's matching contribution. Using tax-free assets to pay medical expenses in retirement is a great strategy to hold down income taxes and to reduce the possibility of being hit with high-income surcharges on Medicare premiums.
In order to utilize an HSA, one must be enrolled in a high-deductible health insurance plan and cannot be enrolled in Medicare. For 2017, the IRS defines a high-deductible health plan as a plan with an annual minimum deductible of $1,300 for self-only coverage and $2,600 for family coverage — the same as this year. The maximum annual out-of-pocket expenses for 2017, including deductibles, co-payments and other amounts, have also not increased. They remain $6,550 for self-only coverage and $13,100 for family coverage.
And therein lies the problem for some HSA account holders next year.
The Department of Health and Human Services issued final regulations last spring that will make it virtually impossible for health care plans offered on the government health exchanges to comply with both HSA rules and the Affordable Care Act. The rule, known as “standardization” will remove HSAs from the exchanges starting in 2017. These new rules do not apply to high-deductible policies offered through employer-based group health insurance plans.
For a plan to meet the qualifications of one of the standard options on the exchanges, it must conform to a uniform set of features related to deductibles, out-of-pocket limits, co-payments and coinsurance levels. Plus, first-dollar coverage must apply to specific services. But the standard option deductibles and out-of-pocket limits of the new rules contradict the requirements to be considered an HSA. And the requirement that high-deductible policies offered on the health care exchange provide first-dollar coverage for non-preventive services eliminate HSAs entirely.
“These new plan designs are optional for 2017 and most likely mandatory in 2018,” said Peter Stahl, founder of Bedrock Business Results, which provides training and resources for financial advisers on retiree health issues and costs. “You'll have few, if any, HSAs on federal exchanges next year,” he predicted.
In a letter to the Centers for Medicare & Medicaid Services, Acting Administrator Andy Slavitt and 22 Republican senators posed a series of questions about the reason for the new rules. “It is clear to see the potential disruption in consumer choice by creating the 'standard option' and limiting the types of plans that qualify for it to exclude HSAs,” the lawmakers said. “These accounts have been widely popular, [but] your agency continues to try to suppress these popular plans.”
Although most financial advisory clients probably get their health insurance through their employer-provided plans, clients who retire early and are too young for Medicare may turn to the health care exchanges for coverage, Mr. Stahl said. If they are looking for a high-deductible plan to qualify them for an HSA contribution next year or beyond, they may be out of luck.
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Mary Beth Franklin is a contributing editor to arjuna-design and a certified financial planner.