As part of ThinkAdvisor’s Special Report, 21 Days of Tax Planning Advice for 2014, throughout the month of March, we are partnering with our Summit Professional Networks sister service, Tax Facts Online, to take a deeper dive into certain tax planning issues in a convenient Q&A format.
Q: What is a health savings account (HSA) and who is eligible?
An HSA is a trust created exclusively for the purpose of paying qualified medical expenses of an account beneficiary.
An HSA must be created by a written governing instrument that states:
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(1) no contribution will be accepted except in the case of a rollover contribution unless it is in cash or to the extent that the contribution, when added to previous contributions for the calendar year, exceeds the contribution limit for the calendar year;
(2) the trustee is a bank, an insurance company, or a person who satisfies IRS requirements;
(3) no part of trust assets will be invested in life insurance contracts;
(4) trust assets will not be commingled with other property, with certain limited exceptions; and
(5) the interest of an individual in the balance of his or her account is non-forfeitable.
HSAs are available to any employer or individual for an account beneficiary who has high deductible health insurance coverage. An eligible individual or an employer may establish an HSA with a qualified HSA custodian or trustee. No permission or authorization is needed from the IRS to set up an HSA. As mentioned above, any insurance company or bank can act as a trustee. Additionally, any person already approved by the IRS to act as an individual retirement arrangement (IRA) trustee or custodian automatically is approved to act in the same capacity for HSAs.
Although an HSA is similar to an IRA in some respects, a taxpayer cannot use an IRA as an HSA, nor can a taxpayer combine an IRA with an HSA.
Contributions to an HSA generally may be made either by an individual, by an individual’s employer, or by both. If contributions are made by an individual taxpayer, they are deductible from income. If contributions are made by an employer, they are excluded from employee income.
An HSA itself is exempt from income tax as long as it remains an HSA.
Contributions may be made through a cafeteria plan under IRC Section 125.
Distributions from HSAs are not includable in gross income if they are used exclusively to pay qualified medical expenses. Distributions used for other purposes are includable in gross income and may be subject to a penalty, with some exceptions.
An employer’s contributions to an HSA are not considered part of a group health plan subject to COBRA continuation coverage requirements. Therefore, a plan is not required to make COBRA continuation coverage available with respect to an HSA.