Health Savings Accounts: At the Intersection of Healthcare and Tax Reform

Anybody following the headlines during the first half of 2017 is well aware of the legislative efforts underway to reform national healthcare policy. A process that began with a simple rallying call of “repeal and replace” quickly found itself bogged down, trudging through the complex reality of the political trenches. To date, the Republicans have managed to pass an amended version of their healthcare reform bill, the American Health Care Act of 2017 (“AHCA”), through the House of Representatives. The bill awaits Senate deliberation, and the anticipation is that further amendments will be forthcoming.

Among the many contentious policy changes swirling within the AHCA, the issue of enhancing Health Savings Accounts (HSAs) has so far proven to be a resilient feature of the bill. This is no surprise, as Republicans have long been advocating for the expansion of HSA accounts as a feature of their plan to expand consumer-directed health care. Their theory is that consumers, with the incentive to shop around for their health care, will force the industry to adapt with changes that ultimately lower costs while increasing the quality of care.

As a tax-advantaged savings account, an HSA gives consumers the attractive opportunity to grow a triple-tax advantaged nest egg. HSAs are funded with pre-tax dollars, are allowed to grow without incurring any taxes on investment income, and the funds can be withdrawn tax-free at any time for qualified medical expenses. Upon reaching the age of 65, an HSA beneficiary gains the additional flexibility of being able to utilize the HSA in a manner similar to a traditional IRA. HSA funds can be withdrawn for any reason without incurring a penalty, and a distribution is only subject to income taxes if it is not used for medical expenses.

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Under current rules, an HSA must be tied to a high-deductible health plan. The high-deductible plan protects a consumer from catastrophic medical expenses, but day-to-day expenses are largely covered out-of-pocket. This results in a greater incentive for consumers to be discerning with the health care choices they make. The Republicans hope to expand this style of consumer-directed health care by proposing enhancements to HSAs that would make them even more attractive to taxpayers. The AHCA proposed the following significant changes to HSAs:

• Increase the annual limit on HSA contributions to match the annual deductible and out-of-pocket expenses under a high-deductible plan.
• Allow both spouses who are eligible for HSA catch-up contributions to make the contributions to the same HSA account.
• Lower the penalty from 20% to 10% for an HSA withdrawal used to pay unqualified medical expenses.
• Allow people to use their HSAs to pay for over-the-counter medications not prescribed by a physician.
• Permit an HSA to be used to pay certain medical expenses incurred before the HSA was established (as long as the account was established within 60 days).

Even if the Senate does not pass the AHCA in its current form, lawmakers in the debate support expanding the benefits of HSAs. For instance, other bills have proposed to eliminate the requirement that a participant in an HSA be enrolled in a high deductible health care plan (HSA Expansion Act of 2017) or to make Medicare Part A (hospital insurance benefits) beneficiaries eligible to participate in an HSA (Health Savings Act of 2017). Combining the current tax advantages of an HSA with these proposed benefits would result in an increasingly powerful tax planning tool.