High-Deductible Health Plans, HSAs, MSAs, FSAs, and Cafeteria Plans
Consumers or employers are sometimes attracted to high-deductible health plans (HDHPs) because the premium costs for such plans are lower than premiums for more comprehensive plans. Under such plans, the individual pays a smaller premium each month and, in return, the individual has a higher deductible and higher out-of-pocket expenses until catastrophic coverage begins. However, high-deductible policies are problematic for consumers who do not have enough money to pay for medical care before their catastrophic coverage begins. Consumers with chronic illnesses, women who use regular preventive care, and older adults may find that their health care costs them significantly more with high-deductible plans. Other consumers often forgo routine preventive care when they must pay for it out-of-pocket.
Before buying a high-deductible plan, consumers should carefully consider the following:
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Can you afford to pay premiums for more comprehensive health coverage?
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What will the plan cover once you reach the deductible? High-deductible policies often do not cover maternity care, doctor visits, and other routine care.
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Do you have enough money to cover your health care expenses until you reach the deductible?
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Once you meet the deductible and coverage begins, will you have enough money for copayments and medical expenses that aren’t covered by your plan?
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What is your out-of-pocket maximum?
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Does the plan cover more after you reach an out-of-pocket maximum?
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What is the lifetime coverage limit?
From a public policy standpoint, the growth in high-deductible plans creates problems in the insurance market. If healthier and wealthier people buy high-deductible policies, their insurance premium dollars do not help to pay (or “spread the risk” of claims) for the general population.
High-deductible plans have been called “consumer-driven health insurance products” by their promoters. People selling these products say that they give the individual the “opportunity” and “responsibility” to manage their health care costs. Whether consumers actually can manage such costs depends on whether they have enough money to pay for their health care, whether they have enough information to make informed choices, and whether they are in a position where they can actually “shop” for medical services. The Kaiser Family Foundation, in its Online Tools for Consumer-Directed Health Plans, discusses efforts to provide consumers with the information they need to make informed choices. In many cases, HDHPs come with a small amount, commonly about $500 per year, that the insurer or employer pays for the employee to use for preventive care. Any additional costs of care are counted toward the deductible. When the deductible (for example $3,000 per person), which is usually significantly higher compared to other insurance plans, is met, the plan has the benefits of a PPO or HMO-type product.
You will find resources about HSAs and public policy on our web page, HSAs: Shop While You Drop. The resources below simply describe three types of tax-advantaged savings accounts that may be coupled with high-deductible policies.
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Health Savings Accounts (HSAs)
What are HSAs?
Health Savings Accounts (HSAs) are savings accounts that can be established by consumers enrolled in high-deductible health plans, who can make tax-favored contributions to the accounts to pay for qualifying health care costs that are not covered by their HDHP. HSAs were created by the Medicare Modernization Act of 2003 and became available on January 1, 2004.
Many people believe that the advent of HSAs will lead to an explosion in interest in high-deductible policies. The tax advantages for HSAs are as follows:
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The funds that are contributed by the employer are not taxed as income;
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The interest or other earnings on the HSA funds are not taxed until distribution, and only then if they are used for something other than qualified health care costs;
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The funds in an HSA can be accumulated from year to year, unlike funds in an FSA; and
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HSA funds are portable, meaning employees can take their funds with them when they change or leave jobs.
HSA funds can be used to pay for copayments, deductibles, and medical expenses not covered by their health plan.
HSAs also have significant limitations:
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The individual must be covered by a HDHP;
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The individual cannot be covered by any other health plan that is not a qualifying HDHP, including Medicare (except individuals may be covered by a limited plan that pays only for dental, vision, disability, long-term care, or a specific illness);
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The individual may not be claimed as a dependent on any other person's tax return; and
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HSA funds cannot be used to pay health insurance premiums.
HDHPs have a deductible of at least $1,150 for individuals and $2,300 for families in 2009. In an HSA, individuals and their employers together can contribute up to $3,000 for coverage for an individual or $5,950 for family coverage in 2009. There is no guarantee that at any given time, the consumer will actually have the amount saved in his or her HSA needed to meet the deductible or cover other out-of-pocket expenses. Depending on the plan type and the out-of-pocket maximums, an HSA could still leave a consumer with significant unreimbursed health care costs. Consumers also will need to manage their funds and understand the associated tax issues, which can be too complex or burdensome for some people, including those with significant illnesses.
Policy note: Many industry groups are touting consumer-driven health plans and HSAs as the next managed care product, promising significant savings on premiums for employers and employees. However, just as managed care produced a decrease in premiums due to the shift of the population into HMOs in the mid-1990s, only to have the premiums rebound when significant numbers of new individuals stopped buying the plans, consumer-driven health products may produce the same effect. Consumers should carefully take note of any shift in their total health care costs from premium costs to out-of-pocket costs and not be mislead by incomplete statements about cost. [Back to HSA list]
Information on HSAs
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Tax Relief and Health Care Act of 2006
President Bush signed the Tax Relief and Health Care Act of 2006 into law on December 20, 2006. This act will have several effects on the laws governing HSAs for the next few years.
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Individuals may now transfer funds from FSAs and HRAs to HSAs until the end of 2011. The contribution may be as large as the balance of the FSA or HRA was on September 21, 2006, or if smaller, the balance at the time of the transfer. The limit is one contribution from each FSA or HRA per person. If the individual becomes ineligible in the 12 months after the transfer, the transfer amount is included in income and subject to a 10 percent additional tax.
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HSA contributions are no longer pro-rated based on the month a person becomes eligible in the year. Individuals may now make the full contribution regardless of when they become eligible in relation to January. If the person does not stay eligible for the 12 months following the last month of the year of the first year of eligibility, a portion of the contributions will be included in income and subject to a 10 percent additional tax.
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Individuals may make a one-time, tax-free contribution to their HSAs from their IRAs. The contribution must be a direct trustee-to-trustee transfer and may be no larger than the maximum HSA contribution for one year. If the individual does not remain eligible for 12 months after the transfer, the amount will be included in income and subject to a 10 percent additional tax.
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Employers can now contribute comparably more to the HSAs of their low-income employees. This comes through an exception to the comparability rules that originally stated that the contributions had to be the same amount or percentage of deductibles for employees in the same category of coverage.
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Medical Savings Accounts (MSAs)
Medical Savings Accounts (MSA) were created for the self-employed and individuals who work for small employers (employers with fewer than 50 employees). MSAs are tax-free savings accounts that can be used to pay for medical expenses that are not covered by a person’s health plan. Like an HSA, to participate in an MSA, the individual must be in a high-deductible health plan. However, the rules for the high-deductible health plan are slightly different for MSAs: The annual deductible was higher—a minimum of $1,900 for 2007 for an individual.
Because MSAs were essentially an experiment by Congress and the MSA pilot period has ended, the only people who may participate in an MSA in 2004 and beyond are individuals who were actively participating in an MSA in 2003 or who begin working for an employer who continues to actively use an MSA as part of the employee health plan. MSAs may eventually be replaced by HSAs. [Back to HSA list]
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Flexible Spending Accounts (FSAs)
Flexible Spending Accounts (FSAs) are tax-free savings accounts that can be used for unreimbursed medical expenses. The funds in these accounts must be set aside by the employee alone. Unlike MSAs and HSAs, there are no restrictions on the types of health coverage an individual participating in an FSA must have. However, the significant downside to FSAs is that at the end of each year, any unspent funds are forfeited to the employer. [Back to HSA list]
Cafeteria Plans
Cafeteria Plans (also called Section 125 plans after Section 125 of the Internal Revenue Code) allow employees to set aside pre-tax dollars for a variety of benefits, including FSAs and health insurance. Some states encourage or require certain businesses to establish cafeteria plans so that their workers will be able to pay for their share of health premiums with pre-tax dollars.
- Using Section 125 Premium-Only Plans to Expand Health Coverage discusses how Section 125, or "cafeteria" plans, may be able to expand coverage, or at least make employer-based coverage more affordable for those who already have it, by allowing employees to pay their premiums with pre-tax dollars. This brief also examines policies that states are using to encourage greater adoption of cafeteria plans. (October 2008)
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