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New Cure for Health Care Rising Costs Part I

By: Richard Feldman

By: Richard Feldman, CFP, MBA, AIF

Sky Rocketing Health Care Costs are a serious threat to Americans financial well being. The cost and percentage increase of insurance and medical treatment is alarming. President Bush and congress targeted this problem with a new Medicare act that was signed into law in December of 2003. The health savings accounts (HSAs), a provision contained in the Medicare Prescription Drug, Improvement, and Modernization Act provide individuals, families, and small businesses provide a way to deal with rising health care costs. Newt Gingrich calls the introduction of health savings accounts (HSAs) which was passed in November 2003 the single most significant transformation that can be made in saving the country from skyrocketing heath costs.[1]

How Health Savings Accounts Work

Starting in 2004, eligible individuals can begin making tax-deductible contributions to HSAs. The accounts are very similar to Individual Retirement Accounts (IRAs). If you are eligible for an HSA than you can contribute anytime after the first day of your tax year and before the date you must file your tax return without extensions. Contributions made by individuals and employers are 100% tax deductible without any nasty phase out provisions. HSA contributions are claimed on page 1 of your form 1040 (an above the line deduction) which means you do not have to itemize to get this deduction.

HSA contributions can be made if you are covered by a high-deductible health insurance plan (HDHP). You are considered to have a HDHP if your health insurance plan has a deductible of $1,000 for self coverage or $2,000 for family coverage. If you meet the insurance deductible requirement, the maximum HSA contribution for 2004 indexed for inflation is $2,600 for individuals and $5,150 for families. Individuals and their spouses between the ages of 55 and 65, can also make catch up contributions of $500 in 2004. This amount will increase in $100 increments each year to a maximum catch up contribution amount of $1,000 in 2009.

Eligibility

IRS notice 2004-2 states that only an eligible individual can establish a health savings account. To be eligible, a person must (1) be covered by a so-called high deductible health insurance plan (HDHP); (2) not be covered by another health plan  a spouses lower deductible plan at work; (3) be younger than 65; and (4) not be claimed as a dependent on anothers tax return.

If you have self-only health coverage, it cannot require more than $5,000 in annual out of pocked payments for covered benefits. The same holds true for family coverage except the amount is $10,000 out of pocket.

Qualified and Non-Qualified Withdrawals

Individuals and families may take federal-income tax-free withdrawals from the account to pay uninsured medical expenses for yourself, your spouse, and your dependents. You however cannot take tax-free withdrawals to pay the premiums for your high-deductible health coverage. Many expenses not covered by traditional health insurance qualify for tax-free withdrawals such as: vision care, dental care, prescription and certain nonprescription drugs, long-term care services, long-term care premiums. You can also use the account to pay health insurance premiums should you get laid off, disabled, or if you change jobs and continue insurance through Cobra. If you withdraw funds before age 65 for any reason other than to pay qualified medical expenses you will owe ordinary income tax plus a 10% penalty. The 10% penalty is waived in cases of death and disability.

After age 65, you can withdraw funds for any purpose without penalty. Amounts that are withdrawn for any purpose other than qualified medical expenses are taxable. Some items that are qualified medical costs include: healthcare costs including Medicare Part A and B premiums, Medicare HMO premiums, insurance deductibles and co-payments, prescriptions.

Summary

The best feature about the new HSA is the ability to build up a large reserve in order to pay future medical costs if you have minimal current health care costs. The HSA fund does not have to be emptied at the end of the year like the old Medical Savings accounts. The account builds up just like an IRA, income and capital gains earned on the account accumulate tax-deferred. HSA accounts will allow small business owners to cut their health care costs and provide tax benefits for themselves and their employees (see my next article on HSAs and Small Business Owners).

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[1] Modern Medicine, Taggart, Gregory; Bloomberg Wealth Manager, April 2004