3.2 Health Savings Accounts (HSAs) and Archer MSAs

If you are covered by a qualifying high-deductible health plan (HDHP), your employer may make tax-free contributions to a health savings account (HSA) on your behalf. Earnings accumulate tax free within an HSA and distributions are tax free if used to pay your qualified medical expenses, or those of your spouse or dependents. If your employer does not make the maximum tax-free contribution to your HSA, you can make a deductible contribution, so long as the total does not exceed the annual contribution limit (see below).

Archer MSAs are an older type of medical savings plan that HSAs are intended to replace. If your employer set up an Archer MSA on your behalf before 2008, or you became eligible to participate after 2007 in a pre-2008 plan, your employer may continue to contribute to the account. If you work for an eligible small employer with a high-deductible plan, your employer may make tax-free contributions to an Archer MSA on your behalf. A rollover can be made from an Archer MSA to a new health savings account (HSA) that accepts rollovers. If the Archer MSA is retained, withdrawals will be tax free if used to pay qualified medical expenses for you, your spouse, or your dependents.

Health Savings Account (HSA)

You may set up an HSA only if you are covered by a qualifying high-deductible health plan (HDHP, see details below), you are not enrolled in Medicare, and you are not the dependent of another taxpayer. Generally, you must have no coverage other than HDHP coverage, but there are exceptions. You are allowed to have separate coverage for vision, dental, or long-term care, accidents, disability, per diem insurance while hospitalized, insurance for a specific disease or illness, car insurance (or similar insurance for owning or using property), or insurance for workers’ compensation or tort liabilities. Preventive care is also exempt from the deductible requirement.

As an eligible employee, you, your employer, or both may contribute to your HSA. The same maximum annual contribution limit applies (see below) regardless of the number of contributors. Your employer may allow you to make pre-tax salary-reduction contributions to an HDHP and HSA as an option under a “cafeteria” plan (3.13).

Filing Tip

Above-the-Line Deduction for HSA Contributions

If you are an eligible employee, contributions you make to your HSA are reported on Form 8889 and deducted on Line 25 of Form 1040; see 3.2 for contribution limits. The deduction is “above the line,” so it is allowed even if you claim the standard deduction.

If you are self-employed, you may claim the “above-the-line” HSA deduction subject to the same limits; see Chapter 41 for further details.

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High-deductible health plan (HDHP).

An HDHP must have a minimum annual deductible and an annual out-of-pocket maximum. For 2012, the minimum plan deductible is $1,200 for self-only coverage or $2,400 for family coverage. For 2013, the minimum deductible is $1,250 (self-only coverage) or $2,500 (family coverage). Out-of-pocket costs for 2012 are limited to $6,050 for self-only coverage or $12,100 for family coverage and for 2013 the limit increases to $6,250 for self-only coverage and $12,500 for family coverage. The limit for out-of- pocket costs covers plan deductibles, copayments and other out-of-pocket expenses, but not premiums.

In the case of family coverage, the terms of the HDHP must deny payments to all family members until the family as a unit incurs annual covered expenses in excess of the minimum annual deductible ($2,400 for 2012; $2,500 for 2013). Thus, a plan would not be a qualified HDHP for 2012 if it allowed payment of an individual family member’s medical expenses exceeding $1,200 (the minimum deductible for self-only coverage) but the family as a whole did not have expenses over $2,400.

However, the minimum annual HDHP deductible does not apply to preventive care benefits. The plan can qualify as an HDHP even if it pays for preventive care without a deductible or after a small deductible (below the regular HDHP minimum). The IRS has provided a safe harbor list of preventive care benefits, including annual physicals, routine prenatal and well-child care, immunizations, tobacco cessation and obesity programs, and screening services for a broad range of conditions including cancer (such as breast, cervical, prostate, ovarian, and colorectal cancer) and cardiovascular disease. Prescription drugs qualify for the preventive care safe harbor if taken by asymptomatic patients with risk factors for a disease, or by recovering patients to prevent the recurrence of a disease.

By law, prescription drug coverage, other than coverage meeting the preventive care safe harbor, is not a permitted exception to the high-deductible requirement. This is a problem for employees whose employers offer separate prescription drug plans that provide first-dollar drug coverage with either a flat dollar or percentage co-payment. HSA contributions cannot be made for individuals with an HDHP and such a prescription drug plan because the prescription drug benefits are not subject to the HDHP minimum annual deductible.

Maximum annual HSA contribution for employees.

For 2012, the maximum HSA contribution for an employee with self-only coverage is $3,100, and for an employee with family coverage, the maximum contribution for 2012 is $6,250. For employees who are age 55 or older in 2012, an additional “catch-up” contribution of $1,000 may be made. The applicable limit must be reduced by any contributions to an Archer MSA. For 2013, the self-only contribution limit will increase to $3,250, and the limit for family coverage will increase to $6,450, plus the additional $1,000 catch-up for those age 55 or older; the $1,000 catch-up is fixed by statute.

If you become eligible under an HDHP, contributions are allowed for the months prior to your enrollment in the HDHP, provided you are eligible in December of that year. However, the contributions for the months prior to your enrollment will be included in your income and subject to a 10% penalty if you do not remain eligible for the 12 months following the end of the first eligibility year, unless you are disabled (or die).

All employer contributions must be reported on Form 8889, which you attach to your Form 1040. Contributions by your employer up to the above limit are tax free and are not subject to withholding for income tax or FICA (Social Security and Medicare) purposes. All employer contributions to an HSA are reported in Box 12 of Form W-2 with Code W. Contributions exceeding the excludable limit are also reported in Box 1 of Form W-2 as taxable wages. If you do not remove an excess contribution (and any net income) by the due date for your return (including extensions), the excess is subject to a 6% penalty; see the instructions to Forms 8889 and 5329.

If your employer contributes less than the limit, you may contribute to your HSA but the same overall limit applies to the aggregate contributions. Contributions you make are reported on Form 8889 and deductible “above the line” from gross income on Line 25 of Form 1040. You must attach Form 8889 to your Form 1040.

Planning Reminder

One-Time Transfer From IRA to HSA

You can make a one-time tax-free transfer from your IRA or Roth IRA to your HSA. A qualifying transfer is not taxable or subject to the 10% penalty for distributions before age 59½. Generally, only one IRA/Roth IRA transfer to an HSA is allowed during your lifetime, but if a transfer is made to a self-only HDHP, and later in the same year you obtain family HDHP coverage, a second transfer from an IRA or Roth IRA may be made in that year. The transfer (or transfers) count towards the annual HSA contribution limit for that year, so if the transfer exceeds the annual HSA contribution limit, the excess is taxable (and possibly subject to the pre-59½ penalty). If you want to transfer amounts from more than one IRA or Roth IRA to an HSA, you have to first roll the funds into a single IRA/Roth IRA and then make the transfer from that account.

To be tax free, the transfer must be directly to the HSA trustee or custodian. Furthermore, you must remain HSA-eligible (have qualifying HDHP coverage) for 12 months following the date of the distribution; otherwise, the distribution is taxable (and possibly subject to the pre-59½ penalty) in the year that you cease to be eligible. Changing from family-HDHP coverage to a self-only HDHP during the 12-month testing period is not considered a cessation of HSA eligibility.

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Archer MSAs

Most employers have replaced Archer MSAs (medical savings accounts) with HSAs. However, an Archer MSA that is not rolled over to a new HSA may continue to be funded.

To contribute, you must have coverage under a high-deductible health plan and must work for a “small employer,” one that had an average of 50 or fewer employees during either of the two preceding years. For 2012, the minimum deductible for self-only coverage is $2,100 and the maximum deductible must be no more than $3,150. For family coverage, the deductible must be at least $4,200 and no more than $6,300. The high-deductible plan must limit out-of-pocket expenses (other than premiums) for 2012 to $4,200 for self-only coverage and $7,650 for family coverage.

Generally, you are not eligible for an Archer MSA if you have any other health insurance in addition to the high-deductible plan coverage, except for policies covering only disability, vision or dental care, long-term care, or accidental injuries, or plans that pay a flat amount during hospitalization.

Employer contribution limits.

Your employer’s contributions to your Archer MSA are tax free up to an annual limit of 65% of the plan deductible if you have individual coverage and 75% of the deductible for family coverage. The limit is reduced on a monthly basis if you are not covered for the entire year. For example, if for all of 2012 you were covered by a qualifying family coverage high-deductible plan with a $6,300 annual deductible, the maximum tax-free contribution is $4,725 (75% of $6,300). If you had coverage for only 10 months, the limit would be $3,937 (¹⁰/₁₂ × $4,725). All employer contributions to your Archer MSA are reported in Box 12 of Form W-2 (Code R). If the contributions exceed the tax-free limit, the excess is reported in Box 1 of Form W-2 as taxable wages. You must report all employer contributions on Form 8853, which you attach to your Form 1040.

If your employer makes any contributions to your account, you may not make any contributions for that year. In addition, if you and your spouse have family coverage under a high-deductible plan and your spouse’s employer contributes to his or her Archer MSA, you cannot contribute to your Archer MSA. If your employer (or spouse’s employer) does not contribute, you may make deductible contributions up to the above employer contribution limits. You report your contributions on Form 8853 and claim your deduction on Line 36 of Form 1040; label it “MSA.” Contributions exceeding the annual limit are subject to a 6% penalty.