Health savings accounts new option for controlling health care costs

There is a new option available to every veterinarian, whether seeking health care insurance coverage for themselves and their families or affordable options for the employees of their practice.

Thanks to the Medicare Prescription Drug Improvement and Modernization Act of 2003, signed into law in December 2003, a provision created a unique tax-favored savings device that will benefit many veterinarians. The new law permits eligible individuals to establish so-called "health savings accounts" or HSAs.

The question of affordable health care insurance has been a troubling one for many veterinarians. Today, every veterinarian can begin to benefit from an HSA. An HSA is established to receive so-called tax-favored contributions by-or on behalf of-eligible individuals. Amounts paid into an HSA may be accumulated over the years or they can be distributed on a tax-free basis to pay or reimburse qualified medical expenses.

Troubling question

Think IRA (individual retirement account). When contributions are made by an employer to an employee's IRA, the contributions are tax deductible by the employer but don't increase the tax bill of the employee. Where those contributions are made directly by the individual, they may be excluded from income. In every case, the income from the funds that remain in those accounts remain in the IRA without impacting the tax bill of the individual.

When it comes to an employer's contributions to an HSA, those contributions are treated as employer-provided coverage for medical expenses under an accident or health plan. In other words, those amounts are tax deductible by the veterinary practice.

However, although the contributions are fully deductible by the employer, the amounts contributed are, at the same time, excludable from the employee's gross income. What's more, contributions aren't subject to income tax withholding for FICA or FUTA. That's right. No withheld amounts for Social Security, unemployment taxes and the like. Without withholding, no employer matching contributions are necessary.

The new HSA differs from an Archer Medical Savings Account or MSA that has been kicking around for a number of years.

How different?

MSAs were created under a pilot program and were available only to small businesses, employers and self-employed individuals to pay health care expenses. Individuals had to be covered under a high deductible health insurance plan. However, the program was limited and the number of individuals who created MSAs was far fewer than anticipated.

Under flexible spending accounts (FSAs), such as MSAs, the unused balance may not be rolled over from year-to-year. The balances that remain in an HSA account can, however, be rolled over. This provides the potential for creating a sizable nest egg for a healthy worker and his or her family-or for the veterinarian. What's more, those funds can be withdrawn after retirement for non-medical purposes penalty-free.

Unfortunately, non-medical withdrawals in later years will not always be tax-free.

According to many experts, HSAs will flourish as both individuals and their employers learn more about them and the many benefits they offer.

Predicted to flourish

In fact, those same experts expect Congress to make HSA compatible with traditional FSAs and health reimbursement arrangements (HRAs) before the end of 2004.

Whether used by the veterinary practice that does not provide health care insurance to its workers or a practice that wishes to reduce the costs of providing such insurance to the principal as well as to the workers, HSAs offer a number of benefits.

Nitty gritty

An HSA is a tax-exempt trust or custodial account, much like an IRA, established exclusively for the purpose of paying the qualified medical expenses of the account's beneficiary.

Under the new rules, a so-called "eligible individual" is considered to be any person who is covered under a high-deductible health plan (HDHP). The individual cannot also be covered by any other health plan that is not HDHP nor can they be entitled to benefits with Medicare.

When the new rules refer to an HDHP, they mean a health plan that requires high deductibles and out-of-pocket expenses. Specifically, for self-only coverage, an HDHP must have an annual deductible of at least $1,000 and annual out-of-pocket expenses required to be paid (deductibles, co-payments and other amounts, but not premiums) not exceeding $5,000.

For family coverage, an HDHP is a plan that has an annual deductible of at least $2,000 and annual out-of-pocket expenses required to be paid not exceeding $10,000.

Fortunately, an individual does not "fail" to be eligible for an HSA merely because they have other coverage. In fact, in addition to an HDHP, coverage relating to liabilities incurred under workers compensation laws, tort liabilities relating to ownership or use of property, insurance for a specified disease or illness or insurance that pays a fixed amount per day of hospitalization, are all permissible.

Insurance coverage that is permitted under the HSA rules also includes accident, disability, dental care, vision care or long-term care insurance. Having these types of insurance will not result in the loss of HSA eligibility.

While any eligible individual may contribute to an HSA, when it comes to an HSA established by an employer, either the employer or the employee may contribute. For an HSA established by a self-employed veterinarian (or unemployed individual), only the individual may contribute to the HSA. And, naturally, there are limits to the amounts that may be contributed to an HSA.

Contributions

The maximum annual contribution to an HSA is the sum of the limits determined for each month, based on status, eligibility and health plan coverage as of the first day of the month. For calendar year 2004, the maximum monthly contribution for eligible individuals with self-only coverage under an HDHP is Ø of the lesser of 100 percent of the annual deductible under the HDHP (minimum of $1,000) but not more than $2,600.

Maximum

For eligible individuals with family coverage under an HDHP, the maximum monthly contribution is Ø of the lesser of 100 percent of the annual deductible under the HDHP (minimum $2,000) but not more than $5,150.

Individuals who reach age 55 by the end of the tax year can boost their annual contributions by $500 for 2004, $600 next year, $700 for 2006, $800 for 2007, $900 for 2008 and $1,000 for 2009 and thereafter. Contributions cannot be made after the participant retires.

Consider John Smith, a veterinarian, who begins self-only coverage under an HDHP on June 1, 2004 and continues to be covered for the rest of the year. The amount deductible is $5,000 for the HDHP. Thus, the contribution allowed is the lesser of the annual deductible of $2,600. The monthly contribution limit is $216.67 ($2,600 divided by 12). His annual contribution limit is $1,516.69 (7 months x $216.67).

Even before the Medicare law was signed, existing tax law permitted self-employed veterinarians to deduct amounts paid for health insurance premiums. For 2003 and thereafter, self-employed veterinarians may deduct from their gross income, 100 percent of amounts paid during the year for health insurance for themselves, spouses and dependents.

Self-employed option

The deduction is limited to the taxpayer's net earned income derived from the veterinary practice for which the insurance plan was established, minus the deduction for 50 percent of the self-employment tax and/or the deduction for contributions to a Keough, self-employed SEP or SIMPLE plan. Amounts eligible for the deduction do not include amounts paid during any month, or part of a month, that the self-employed veterinarian was eligible to participate in a subsidized health plan maintained by their employer or the spouse's employer.

Thanks to the Medicare Prescription Drug, Improvement and Modernization Act of 2003, veterinarians, their practice, employers, employees and other workers have a new tax-deferred method of coping with rising health care costs. HSAs are a unique tax-saving tool that enables workers with high-deductible health insurance to make pre-tax contributions of up to $2,600 each year ($5,150 for families) to cover health care costs.

HSA in everyone's pocket

The Medicare Act also provides a 28 percent excludable subsidy for employers that maintain retiree prescription drug coverage once the Act's new drug benefits start in 2006. But those are the HSAs that will benefit so many veterinarians.

Anyone may set up an HSA after Jan. 1, 2004. Employers who have undertaken regular medical plan elections for 2004 may terminate that traditional health plan at any time and start offering the combination HSA/high-deductible health plan immediately in 2004. If an existing plan makes a promise to provide a certain benefit for a period of time, the veterinary practice/employer must, of course, honor that commitment before switching.

HSAs provide another option in the arsenal of weapons available to every veterinarian fighting the high costs of health care protection. Its flexibility permits every veterinarian to benefit while, if desired, contributing funds to the HSAs of the employees of the veterinary practice-with the accompanying tax breaks, of course.

Another option

Mr. Battersby is a financial consultant in Ardmore, Pa.