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While the cost of healthcare continues to rise, more employers are transferring this burden to their employees. Meanwhile, families and individuals wrestle with affordability in the face of rising healthcare costs. In an attempt to address growing concerns related to healthcare costs, health savings accounts (HSAs) were created by the Medicare Prescription Drug Improvement and Modernization Act of 2003, which was signed by President Bush on December 8, 2003. HSAs are designed to help individuals save for future qualified medical and retiree health expenses on a tax-free basis.1 This article uses the most recent literature issued by the United States Department of the Treasury to define the HSA, focusing on eligibility, contribution requirements, and restrictions, and will also examine the role banks play in offering the HSA as a new product, since banks are qualified to serve as the custodian or trustee of HSAs.
What Is an HSA?
An HSA is a special account owned by an individual to pay for current and future medical expenses, and it is used in conjunction with a High Deductible Health Plan (HDHP). For 2007, an HDHP is defined as a health insurance plan with a minimum deductible of $1,100 for self coverage and $2,200 for family coverage. Annual out-of pocket expenses, which include deductibles and co-pays, cannot exceed $5,500 for self coverage and $11,000 for family coverage during 2007. The aforementioned amounts are all annually indexed for inflation.
Eligibility to establish an HSA is not determined by income levels, nor are qualifying individuals required to have earned income to contribute to an HSA. They must be covered by an HDHP, must not be covered by other health insurance, must not be enrolled in Medicare, and cannot be claimed as a dependent on someone else's tax return.2 Qualifying individuals may have additional health care coverage in the following forms: insurance covering specific diseases or illnesses; accident and long-term care insurance; and dental, vision, or disability coverage.
Likewise, participation in employee assistance, disease management, and wellness programs is permitted, based on the condition that the programs do not provide significant medical care or treatment. Furthermore, the use of drug discount cards is permitted in conjunction with HSAs. Individuals eligible for an HSA may also be eligible for VA benefits, unless benefits have been received within the three months prior to opening an HSA.
Employers, individuals, and families are permitted to contribute to an HSA. Moreover, as of this year, individuals are permitted to make a one-time transfer from their Individual Retirement Account (IRA) to an HSA, in accordance with the contribution limits for the appropriate year of the transfer. The 2007 maximum that can be contributed to a HSA from all sources is $2,850 for self coverage and $5,650 for family coverage. These amounts are indexed annually. However, individuals who are aged 55 years or older are allowed "catch-up" contributions to an HSA in amounts totaling $800, $900, and $1,000 for the years 2007, 2008, and 2009, respectively. Enrolling in Medicare would prohibit further contributions. Any contributions exceeding the existing limits are subject to excise tax unless withdrawn by the individual. On the other hand, if the HSA limit is not reached for the year and a withdrawal occurs that is not qualified for medical expenses, the withdrawal will be subject to both income tax and a 10 percent penalty. The additional 10 percent penalty is not applicable if the individual dies, becomes disabled, or is over age 65. More details outlining the 2007 applicable rules for HSAs can be found in Internal Revenue Service Publication 969, "Health Savings Accounts and Other Tax Favored Health Plans."3
Banks as Trustees and Custodians
Banks and credit unions are automatically qualified to offer HSAs to their respective customers in the form of trust or custodial accounts. Additionally, insurance companies and other entities that are already approved trustees or custodians of individual retirement accounts (IRAs) qualify. Other entities that want to become approved trustees or custodians of HSA accounts must contact the IRS directly. While trustees may exercise some level of discretionary fiduciary authority over the assets of the fund within the best interest of the beneficiary, the custodian has no fiduciary obligation to the owner of the funds.
Like IRAs, HSAs have many investment options, yet trustees do not have to offer all investment options to account holders. The individual is responsible for determining what to contribute, how much to use for medical expenses, whether to use the account for current or future medical expenses, which company will hold the account, and which type of investments will be used to grow the account. However, custodians and trustees can impose reasonable limits on fund accessibility through the frequency and size of distributions to the account. The fees for such accounts can be paid directly by the beneficiary without being added to the contribution itself or paid directly from the HSA account without taxes or penalties being imposed.
Banks and credit unions are in a unique position to benefit from offering a product like the HSA. The benefits for banks include the generation of fee income and opportunities to cross-sell and broaden their customer base, although the number of community banks within the Third District offering HSAs is very limited right now.
HSA trustees are required to report all distributions annually to the individual through form 1099 SA, and HSA account holders are required to file a form 8889 with their annual tax returns. Trustees or custodians are not required to ascertain whether HSA distributions are used for qualified medical expenses, but individual HSA account holders are required to maintain records of their medical expenses for such purposes.
A Growing Business
HSAs are considered a growing business line and an avenue for cross-selling banking products. The Aite Group, a leading independent research and advisory firm focused on business, technology, and regulatory issues, forecasts that large and specialty banks will be the winners in the health savings account (HSA) market, as they will see significant growth in the number of HSAs they provide. By 2010, large banks will likely support 40 percent of HSAs (up from 20 percent in 2006), and specialty banks will likely support 35 percent of HSAs (up from 30 percent in 2006).4
As banks continue to look for ways to expand their customer base and generate additional fee income, products like the HSA can become very attractive. Banks must be prepared to properly and adequately educate consumers and potential customers about new products or service offerings. According to Joe Donlan, vice president at Subimo, an informational healthcare resource and website, banks will find HSAs difficult to market if they don't provide customers with the tools necessary to make intelligent decisions about their health care savings requirements.5 As with any new product offering, a bank's board of directors and senior management must perform due diligence and ensure that the bank has the appropriate infrastructure and expertise to offer and manage these newer products. Failure to do so could potentially expose the bank to unwarranted operational, legal, and reputational risk.
The board of directors is ultimately responsible for the overall level of risk taken by the institution, and business strategies related to new products (e.g., HSAs) should be approved by the board. While significant policies governing any new products should be documented properly, senior management should also be capable of managing the activities and risk associated with new products. In any event, risk should be identified, measured, monitored, and controlled.
Ongoing risk monitoring and management information systems should be established to provide directors and senior management with a concise understanding of the banking organization's related performance and risk exposure. Management should also establish and maintain an effective system of controls governing the new product offering, which should be reviewed and tested by an independent internal auditor. The results of the review should subsequently be documented and reported directly to the board or audit committee for any needed response or required action.
Third District Perspective
Although there are not many Third District community banks offering HSAs, regulators anticipate that the flattening yield curve may prompt bank management to explore additional opportunities to increase their fee income through new or expanded products. As consumers become more familiar with the benefits offered by HSA ownership, the demand for such product offerings is expected to increase. The HSA may soon become a household name, just like the IRA. Banks and credit unions are uniquely positioned and qualified to offer HSAs to consumers. Even so, any new product offering embodies risk and the potential to negatively impact an institution if the board and senior management fail to exercise due diligence or do not have full knowledge of a product and its potential risk to the organization.
For more information about HSAs, visit the United States Department of the Treasury's discussion of HSAs.
The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.