Health Savings Accounts: Overview of Rules for 2008

Health Savings Accounts:
Overview of Rules for 2008
Updated September 24, 2008
Bob Lyke
Specialist in Social Legislation
Domestic Social Policy Division

Health Savings Accounts: Overview of Rules for 2008
Summary
Health Savings Accounts (HSAs) are one way people can pay for unreimbursed
medical expenses (deductibles, copayments, and services not covered by insurance)
on a tax-advantaged basis. HSAs can be established and funded by eligible
individuals when they have a qualifying high deductible health plan and no other
health plan, with some exceptions. For 2008, the deductible for self-only coverage
must be at least $1,100 (with an annual out-of-pocket limit not exceeding $5,600);
the deductible for family coverage must be at least $2,200 (with an annual out-of-
pocket limit not exceeding $11,200).
The annual HSA contribution limit in 2008 for individuals with self-only
coverage is $2,900; for family coverage, it is $5,800. Individuals who are at least 55
years of age but not yet enrolled in Medicare may contribute an additional $900.
The tax advantages of HSAs can be significant for some people: contributions
are deductible (or excluded from income that is taxable if made by employers),
withdrawals are not taxed if used for medical expenses, and account earnings are tax-
exempt. Unused balances may accumulate without limit.
HSAs and the accompanying high deductible health plans are one form of what
some call “consumer-driven health plans.” One objective of these plans is to
encourage individuals and families to set money aside for their health care expenses.
Another is to give them a financial incentive for spending health care dollars
prudently. Still another goal is to give them the means to pay for health care services
of their own choosing, without constraint by insurers or employers. Since HSAs are
relatively new, the extent to which they will further these objectives is not yet known
with any assurance. Among other things, it remains to be seen how many people will
eventually establish accounts, how much they will contribute to them, and how much
they will carry over to subsequent years.
This report is limited to a summary of the principal rules governing HSAs,
covering such matters as eligibility, qualifying health insurance, contributions, and
withdrawals. It will be updated as the rules change, either by legislation or regulatory
action. The President’s FY2009 budget includes some HSA recommendations that
Congress might consider.
Legislative proposals in the 110^th Congress to change HSA rules are discussed
in CRS Report RL33505, Tax Benefits for Health Insurance and Expenses: Overview
of Current Law and Legislation, by Bob Lyke and Julie M. Whittaker.

Contents
In troduction ......................................................1
HSA Rules.......................................................2
What is an HSA?..............................................2
Who May Have an HSA?........................................3
What Is a Qualifying Health Plan?.................................4
Minimum Deductible.......................................4
Out-of-Pocket Limit........................................5
What Is Disqualifying Coverage?.................................5
Who May Contribute to an HSA?.................................6
When and How May Contributions Be Made to an HSA?..............6
How Much May Be Contributed to an HSA?........................7
Regular Contributions......................................7
Catch-Up Contributions.....................................8
Rollovers ................................................8
Interaction with Medical Savings Accounts.....................8
Excess Contributions.......................................8
Comparability Requirement..................................8
What Is the Tax Treatment of HSA Contributions?...................9
What Is the Tax Treatment of HSA Withdrawals?...................10
What Happens to HSAs at Death?................................11
What Administrative Provisions Apply to HSAs?....................11
Are HSAs Covered by ERISA?..................................12
What State Requirements Apply to HSAs ?........................12
What Are the Administration’s Current Proposals?..................13
Conclusion ......................................................13

Health Savings Accounts:
Overview of Rules for 2008
Introduction
Health Savings Accounts (HSAs) are one way people can pay for unreimbursed
medical expenses (deductibles, copayments, and services not covered by insurance)
on a tax-advantaged basis. HSAs can be established and funded by eligible
individuals when they have a qualifying high deductible health plan (HDHP, i.e.,
high deductible insurance) with a deductible in 2008 of at least $1,100 for self-only
coverage and $2,200 for family coverage. Qualifying HDHPs must also limit out-of-
pocket expenses for covered benefits to certain amounts. With some exceptions,
eligible individuals cannot have other health insurance coverage.
HSA tax advantages can be significant for some people: contributions are
deductible (or excluded from income that is taxable if made by employers),
withdrawals are not taxed if used for medical expenses, and account earnings are tax-
exempt. Unused balances may accumulate without limit.
HSAs were first authorized in the Medicare Prescription Drug, Improvement,
and Modernization Act of 2003 (MMA, P.L. 108-173). However, other tax-
advantaged accounts for health care expenses have existed for some time. Flexible
Spending Accounts (FSAs), which many employees can use, began spreading in the
1980s once the Internal Revenue Service (IRS) established clear guidelines. Archer
Medical Savings Accounts (MSAs), a precursor of HSAs, became available for a
limited number of people starting in 1997. Health Reimbursement Accounts
(HRAs), made available by some employers, were approved for tax-exempt status in
2002.For an overview of the similarities and differences of these accounts, see CRS
Report RS21573, Tax-Advantaged Accounts for Health Care Expenses: Side-by-Side
Comparison, by Bob Lyke and Chris L. Peterson. Also see Internal Revenue Service
publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.
When coupled with high-deductible health plans, these accounts are part of what
some call “consumer-driven health plans.” One objective of these plans is to
encourage individuals and families to set money aside for their health care expenses.
Another is to give them a financial incentive for spending health care dollars
prudently. Still another goal is to give them the means to pay for health care services
of their own choosing, without constraint by insurers or employers.
Since HSAs are relatively new, the extent to which they will further these
objectives is not yet known. Among other things, it remains to be seen how many
people will eventually establish accounts, how much they will contribute to them,
and how much they will carry over to subsequent years. Their effect on health care

use is largely speculative, as is their effect on insurance and health care costs.
However, many individuals and employers are interested in HSAs, and additional
information about them is emerging continually.
This report provides a summary of the principal rules governing HSAs, covering
such matters as eligibility, qualifying health insurance, contributions, and
withdrawals. It will be updated as the rules change, either by legislation or regulatory
action. For current information about legislative proposals to change HSA rules, see
CRS Report RL33505, Tax Benefits for Health Insurance and Expenses: Overview
of Current Law and Legislation, by Bob Lyke and Julie M. Whittaker.
CRS Report RL32467, Health Savings Accounts, by Bob Lyke, Chris Peterson,
and Neela Ranade, provided a comprehensive analysis of HSAs and the issues they
raised as of March 2005. That report will not be updated.
HSA Rules
Rules governing HSAs are laid out primarily in Section 223 of the Internal
Revenue Code and guidance issued by the Internal Revenue Service (IRS). Section

223 of the Code was enacted by the Medicare Prescription Drug, Improvement, and¹

Modernization Act of 2003 (P.L. 108-173, Section 1201(a)). The section has been
amended twice: first by the Gulf Opportunity Zone Act of 2005 (P.L. 109-135,
Section 404(c)), and then by the Tax Relief and Health Care Act of 2006 (P.L. 109-

432). The IRS has issued guidance about HSAs in a number of notices, revenue²

procedures, and revenue rulings since then.
HSAs are affected by other rules as well. For example, whether an expenditure
is a qualified medical expense is governed by Section 213(d) of the Internal Revenue
Code and IRS guidance on it; aside from exceptions pertaining to the purchase of
health insurance, Section 223 does not change these rules.
The summaries of the principal HSA rules that follow do not provide all details
or cite supporting documentation. Further information might be obtained by referring
to the statutory provisions cited above, to IRS and other government publications, or
to a growing body of secondary analyses.
What is an HSA?
An HSA is a tax-exempt trust or custodial account established for paying
qualified medical expenses of the account beneficiary. Accounts may be established
with banks and insurance companies or with other entities approved by the IRS to

¹ Sections 1201(b) through 1201(i) amend a number of other Code provisions that affect the
tax treatment of HSAs, contributions to accounts, and other related matters. Some of the
rules summarized in this report are governed by these provisions rather than Section 223.
² As of September 2008, some of the official guidance was available online at
[ h t t p : / / www.t r easur y. go v/ of f i ces/ publ i c -a f f a i r s/ hsa/ t echni cal -gui dance/ ] .

hold Individual Retirement Accounts (IRAs) or MSAs. In addition, other entities
may request approval to be an HSA trustee or custodian.
Insurance companies that offer qualified high deductible health plans (HDHPs)
often also establish HSAs for the policyholders. However, there is no federal
requirement that HSAs be established by the entity that provides the health plan.
Individuals interested in establishing an HSA must locate an entity that accepts
the accounts; they cannot simply deem an ordinary savings account to be an HSA.
Who May Have an HSA?
Individuals are eligible to establish and contribute to an HSA if they have a
qualifying HDHP and no disqualifying coverage, as discussed under the next two
headings. Whether someone has a qualifying HDHP is determined as of the first of
each month; thus, a person might be eligible to contribute to an HSA in some months
but not others.³ For example, if someone first enrolled in an HDHP on September

15, their HSA eligibility period would begin on October 1 of that year.

Individuals cannot be enrolled in Medicare (a form of disqualifying coverage),
which generally occurs at age 65.⁴ They cannot have received Veterans
Administration medical benefits (another form of disqualifying coverage) within the
past three months, other than benefits for preventive care or from disregarded
coverage (for the latter, see exceptions to disqualifying coverage in the section on
“What Is Disqualifying Coverage?,” below). On the other hand, individuals can be
eligible even if they have access to free or reduced price health services at an on-site
employer clinic, provided the clinic does not offer significant benefits.
Individuals are not eligible if they may be claimed as a dependent on another
person’s tax return. Tax dependency is determined on a yearly basis; this might not
be known until the end of the year.
Individuals may keep their HSAs once they become ineligible. Thus,
individuals do not lose their HSA (or the right to access it) by turning age 65 or by
obtaining insurance with a low deductible. However, they could not make
contributions until they become eligible once again.
Individual members of a family may have their own HSAs, provided they each
meet the eligibility rules just described. They can also be covered through the HSA
of someone else in the family; for example, a husband may use his HSA to pay
expenses of his spouse whether or not she has qualifying coverage and whether or not
she has her own HSA. The husband might use his HSA to pay the spouse’s expenses
even if she has disqualifying coverage. Individuals may have more than one HSA
account.

³ Individuals should be able to find out from their insurer whether their HDHP is qualifying
coverage. They need not apply to the IRS or other government agency for a determination.
⁴ Individuals remain eligible to establish and contribute to HSAs after becoming eligible for
Medicare, provided they do not enroll in either Part A or Part B.

What Is a Qualifying Health Plan?
A health plan must meet several tests to be qualified: it must have a deductible
above a certain minimum level, and it must limit out-of-pocket expenditures for
covered benefits to no more than a certain maximum level. These two tests are
described immediately below.
In addition, a qualifying health plan must provide general coverage:
substantially all of its coverage cannot be through what the statute calls “permitted
insurance” (e.g., coverage for only a particular disease) or certain other coverage
(e.g., vision care). This rule prevents individuals from making HSA contributions
when the only insurance they have is high deductible coverage for a narrow class of
benefits. (More details on permitted insurance and these other forms of coverage are
provided under the heading “what is disqualifying coverage?”)
Minimum Deductible. For self-only coverage, the annual deductible in 2008
must be at least $1,100; for family coverage, it must be at least $2,200. These⁵
amounts will be adjusted for inflation (rounded to the nearest $50) in future years.
Only usual, customary, and reasonable charges for covered benefits are taken
into account in determining whether deductibles are met. Premiums are not included
in meeting the deductible, though copayments may be at the option of the HDHP.
The minimum deductible requirement does not apply to preventive care. The
exception is established in the statutory language, which does not define the term.
However, IRS regulations provide that preventive care includes but is not limited to
periodic health evaluations (including tests and diagnostic procedures ordered in
connection with routine examinations), routine prenatal and well-child care,
immunizations, tobacco cessation programs, obesity weight-loss programs, and
various screening services. Drugs and medications can be included when taken by
a person who has developed risk factors for a disease, or to prevent its recurrence.
In general, preventive care does not include services or benefits intended to treat
existing illnesses, injuries, or conditions; an exception is allowed when the treatment
is incidental to the preventive care service and it would be unreasonable or
impracticable to preform another service.
Prescription drugs are not exempt from the minimum deductible, whether they
are treated like other benefits in the high deductible insurance plan or have different
deductibles and copay requirements. In order to allow health plans time to adjust to⁶

this requirement, the IRS delayed its effective date until January 1, 2006.
⁵ This and other HSA inflation adjustments are based upon the Consumer Price Index for
all urban consumers published by the U.S. Department of Labor. Sec. 304 of P.L. 109-432
provides that the measurement period for HSA inflation adjustments is the 12-month period
ending on March 31 of the prior year. According to Rev. Proc. 2008-29 (issued June 2,
2008), the applicable 2009 amounts are $1,150 for self-only coverage and $2,300 for family
coverage.
⁶ Similarly, the IRS ruled that until January 1, 2006, a plan could qualify as a HDHP even
(continued...)

Prescription or other discount cards do not disqualify individuals from meeting
the minimum deductible requirement. Similarly, individuals are not disqualified by
coverage under an employee assistance program, disease management program, or
wellness program, provided the program does not provide significant benefits in the
nature of medical care or treatment.
Out-of-Pocket Limit. For self-only coverage, the annual limit on out-of-
pocket expenditures for covered benefits must not exceed $5,600 in 2008. For family
policies, the limit must not exceed $11,200. These amounts will be adjusted for
inflation (rounded to the nearest $50) in future years.⁷
These limits should not be interpreted as ceilings on all out-of-pocket
expenditures for health care. Premiums for the HDHP and other insurance would be
extra, as would payments for benefits not covered by insurance. Even for covered
benefits, the limits would apply only to payments for usual, customary, and
reasonable charges. On the other hand, both deductibles and copayments must be
taken into account in determining whether the limits are exceeded.
The out-of-pocket limit rule does not preclude HDHPs from imposing
reasonable lifetime limits (for example, $1 million) on plan benefits.
What Is Disqualifying Coverage?
While covered by a qualifying HDHP, individuals generally must not have other
coverage that is not high deductible and that provides coverage for any benefit under
their high deductible plan. For example, individuals with a qualifying HDHP are not
eligible to establish or contribute to an HSA if they are also covered under a spouse’s
low deductible policy for the same benefits. (If the spouse’s policy were high
deductible, the individual could contribute to his or her own HSA.)
However, eligible individuals may have “permitted insurance,” which is
insurance under which substantially all coverage relates to liabilities incurred under
workers’ compensation laws, tort liabilities, or liabilities related to ownership or use
of property (such as automobile insurance); insurance for a specified disease or
illness; or insurance that pays a fixed amount per day or other period of
hospitalization. In addition, eligible individuals may have coverage (through
insurance or otherwise) for accidents, disability, vision care, dental care, or long-term
care. As mentioned above, the permitted insurance and other coverage described

⁶ (...continued)
if state law required that certain benefits be provided without a deductible or below the
minimum annual deductible. Extensions beyond that date were limited to certain non-
calendar year health plans.
⁷ According to Rev. Proc. 2008-29 (issued June 2, 2008), the applicable 2009 amounts are
$5,800 for self-only coverage and $11,600 for family coverage.

here do not provide the general form of coverage to be considered a qualifying health
plan for purposes of HSA eligibility.⁸
Eligible individuals may also have Flexible Spending Accounts and Health
Reimbursement Accounts, provided these accounts are for limited purposes (for
example, dental services or preventive care), provide reimbursement for services
covered by the HDHP only after the qualifying deductible is met, or are used in
retirement. However, coverage under any Flexible Spending Account is allowed
during the account’s 2½-month grace period after the end of the year (leeway, which
employers may allow), provided the balance in the account is zero or is transferred
to the HSA.
Who May Contribute to an HSA?
Contributions to HSAs may be made by eligible individuals, as well as by other
individuals or entities on their behalf. Thus, individuals may contribute to accounts
of eligible family members, and employers may contribute to accounts of eligible
employees. Contributions can also be made by state governments.
Contributions by one individual or entity do not preclude contributions by
others, provided that the total of all contributions (aside from those classified as
rollover contributions) does not exceed annual contribution limits.
Contributors cannot restrict how HSA funds are to be used. For example,
employers may not limit HSAs just to certain medical expenses (let alone just to
medical expenses alone), even for funds they contribute. Account owners always can
make withdrawals for any purpose, though nonqualified withdrawals are subject to
taxation, as discussed below.
When and How May Contributions Be Made to an HSA?
Contributions to HSAs may be made at any time during a calendar year and until
the filing date (without extensions) for federal income tax returns, normally April 15
of the following year. Thus, contributions could occur over a 15½ month time span
(e.g., from January 1, 2008, through April 15, 2009), provided they do not exceed the
allowable annual limit described below.
HSA contributions may be made through cafeteria plan salary reduction
agreements, that is, benefit arrangements established by employers under which
employees accept lower take-home pay in exchange for the difference being
deposited in their account.⁹ The IRS has determined that salary reduction agreements
must allow employees to stop or increase or decrease their HSA contributions

⁸ In private letter ruling PLR 200704010 (January 26, 2007), the IRS provided guidance on
how broad “permitted insurance” and “other coverage” can be without being deemed
disqualifying coverage. While private letter rulings are not precedent, they are often useful
indicators of the tax analysis the IRS applies to a particular issue.
⁹ Health care flexible spending accounts generally are also funded through salary reduction
agreements; however, they have a number of restrictions that do not apply to HSAs.

throughout the year as long as the changes are effective prospectively; however,
employers may place restrictions on these elections if they apply to all employees.
The IRS has also determined that these agreements allow employers to contribute
amounts to cover medical expenses that exceed employees’ current HSA balances
(subject to maximum amounts the employees had elected to contribute), provided the
employees repay the accelerated contributions before the end of the year.
Individuals may make one-time contributions to their HSAs from their traditional
or Roth individual retirement accounts (IRAs), subject to the annual contribution
limits described below, and limited, one-time rollovers from balances in each of their
Flexible Spending Accounts and Health Reimbursement Accounts, which are not
subject to those limits.¹⁰
Contributions to HSAs must be made in cash; contributions of property are not
allowed.
How Much May Be Contributed to an HSA?
Two types of contributions may be made to HSAs, regular and catch-up. Both
have annual limits that are calculated on a monthly basis: for each month during the
year when individuals are eligible, they may contribute (or have others contribute on
their behalf) up to one-twelfth of the applicable annual limit.¹¹ For example, an
individual who is eligible for January through July could contribute seven-twelfths of
the annual limit for that year. However, individuals who are eligible during the last
month of the year are treated as if they were eligible for the entire year, thus allowing
them to contribute up to the annual limit.¹²
Contributions need not actually occur monthly; one contribution can be made for
the entire year, provided it does not exceed the sum of the allowable monthly limits.
Regular Contributions. The annual contribution limit in 2008 for self-only
coverage is $2,900. The annual limit for family coverage is $5,800. The limits will
be adjusted for inflation (rounded to the nearest $50) in future years.¹³

¹⁰ Individuals who make additions to their HSAs under these circumstances must maintain
their HSA eligibility for the following year (except in cases of disability or death);
otherwise, the additions are included in gross income in determining federal income taxes
and also are subject to a 10% penalty tax.
¹¹ The applicable annual limits apply to total contributions to the HSA from all sources (e.g.,
from individuals and employers), not counting rollover contributions. As discussed in the
text, applicable limits are reduced by the amount of any contributions individuals make to
their Medical Savings Accounts the same year.
¹² Individuals who make additional contributions under this rule must maintain their HSA
eligibility for the following year (except in cases of disability or death); otherwise, the
additional contributions are included in gross income in determining federal income taxes
and also are subject to a 10% penalty tax.
¹³ According to Rev. Proc. 2008-29 (issued June 2, 2008), the applicable 2009 amounts are
$3,000 for self-only coverage and $5,950 for family coverage.

In the case of a married couple, if one spouse has family insurance coverage both
will be treated as if they have only that coverage; the monthly contribution limit will
be divided equally between them unless they agree on a different division.
Catch-Up Contributions. These contributions may be made by individuals
who are at least 55 years of age but not yet enrolled in Medicare. In 2008, they may
contribute an additional $900. The annual catch-up amount will increase by another
$100 in 2009, when it will be $1,000. These amounts are not indexed for inflation.
Rollovers. Account owners may rollover balances from one HSA to another
without being restricted by the annual contribution limits or affecting new
contributions. If the owner withdraws funds and deposits them in another account,
only one rollover is allowed each year. Deposits must be made within 60 days in
order for the transfer to be considered a rollover. If instead an HSA trustee transfers
funds to another, there is no limit on the number of rollovers allowed each year. HSA
trustees are not obligated to accept either owner or trustee rollovers.
One-time, limited rollovers are also allowed of termination balances in Flexible
Spending Accounts and Health Reimbursement Accounts. The rollovers must be
made by employer transfers.
Interaction with Medical Savings Accounts. The annual limitations just
described are reduced by the amount of any contribution individuals make to their
MSAs in the same year. (MSAs are precursors to HSAs that were authorized under
the Health Insurance Portability and Accountability Act of 1996, P.L. 104-191.
Eligibility was limited to people who either were self-employed or were employees
covered by a high deductible insurance plan established by employers with 50 or
fewer workers.)
Individuals are permitted to rollover MSA balances to their Health Savings
Accounts.
Excess Contributions. Contributions exceeding annual limits might occur
for a number of reasons, including failure of employees to take account of employer
contributions, early deposits that incorrectly anticipated continuing eligibility, and
mathematical errors.
If an excess contribution and any earnings on it are withdrawn by the filing date
(without extensions) for the federal income tax return for the year, the individual will
not be subject to a penalty. Otherwise, the excess contribution will be subject to a 6%
excise tax each year until it is withdrawn.
Comparability Requirement. Employers are not required to contribute to
employees’ HSAs, but if they do the contributions must be comparable.¹⁴ Generally,

¹⁴ The comparability requirement is in Section 4980G of the Internal Revenue Code, which
references rules for MSAs in Section 4980E. The IRS issued final regulations for
comparability on July 31, 2006 (71 Federal Register 43056) and April 17, 2008 (73 Federal
(continued...)

contributions must be the same dollar amount or the same percentage of the HDHP
annual deductible, adjusted to reflect the proportion of the year the employees have
worked. Varying employer matching contributions (which might differ by how much
an employee puts in) satisfy the comparability requirement only if employee
contributions are made through a cafeteria plan.¹⁵ If employers allow some employees
to transfer Flexible Spending Account or Health Reimbursement Account balances
to their HSAs, they must allow any eligible individual covered under their HDHPs to
do so.
Employers may accelerate part or all of their contributions for employees who
have incurred qualified medical expenses that exceed the employer’s cumulative
contributions to that point in the year. Accelerated contributions must be available on
an equal and uniform basis to all eligible employees.
Employers may limit contributions just to employees who participate in the
employers’ HDHPs; however, if they make contributions to employees who
participate in other HDHPs they must make comparable contributions to all employees
with HDHPs.
Different treatment is allowed for full-time and part-time employees, and for self-
only and several types of family coverage. Larger contributions may be made for
non-highly compensated employees than for highly compensated employees (as
defined by the Internal Revenue Service). Employees covered by collective bargaining
agreements may be disregarded.
The comparability requirement does not apply to HSA contributions to people
who are not considered “employees,” including independent contractors, partners in
a partnership, and sole proprietors.
What Is the Tax Treatment of HSA Contributions?
Individuals who contribute to their HSAs may claim a deduction on their federal
income tax. The deduction is “above-the-line,” that is, it is made in determining
adjusted gross income; it may be taken by all taxpayers, even those who claim the
standard deduction instead of itemizing deductions.
No deduction may be claimed for a one-time contribution from an IRA (though
the IRA distribution is not taxed, as it otherwise might be) or for rollovers from
MSAs, other HSAs, or a Flexible Spending Account or Health Reimbursement
Account.
Contributions made by employers are excluded from gross income of employees
in determining their income tax liability. In addition, employer contributions are

¹⁴ (...continued)
Register 20794). Failure to comply subjects the employer to an excise tax.
¹⁵ Cafeteria plans allow employees to choose among certain nontaxable benefits (or levels
thereof) and cash. Governed by Section 125 of the Internal Revenue Code, they have their
own nondiscrimination rules.

exempt from social security and Medicare taxes for both employers and employees.¹⁶
(Social Security taxes are 6.2% of wages up to $102,000 in 2008; Medicare taxes are
1.45% of total wages.) In addition, employer HSA contributions are exempt from
federal unemployment insurance taxes. If employees contribute to their HSAs through
salary reduction cafeteria plans, the contributions are considered to be made by the
employer and are exempt from these three employment taxes.
State income taxes generally follow federal rules with respect to deductions and
exclusions. However, some states may elect different treatment.
What Is the Tax Treatment of HSA Withdrawals?
Withdrawals from HSAs are exempt from federal income taxes if used for
qualified medical expenses described in Section 213(d) of the Internal Revenue
Code,¹⁷ except for health insurance. While payments for health insurance are
considered qualified expenses under Section 213(d), they generally are not qualified
for purposes of HSAs withdrawals. Thus, accounts cannot be used to pay some or all
of the premiums of the associated HDHP. However, payments for four types of
insurance are considered to be qualified HSA expenses: (1) long-term care insurance,¹⁸
(2) health insurance premiums during periods of continuation coverage required by
federal law (e.g., COBRA), (3) health insurance premiums during periods the
individual is receiving unemployment compensation, and (4) for individuals age 65
years and older, any health insurance premiums (including Medicare Part B
premiums) other than a Medicare supplemental policy.
Withdrawals not used for qualified medical expenses are included in gross
income in determining federal income taxes; they also are subject to a 10% penalty
tax. The penalty is waived in cases of disability or death and for individuals age 65
and older. There is no requirement, as there is for qualified retirement plans, that
individuals begin to spend down account balances at a certain age.

¹⁶ If an individual is self-employed, contributions are not taken into account in determining
net income from self-employment; as a consequence, they are not exempt from Social
Security and Medicare taxes.
¹⁷ Qualified medical expenses are described generally in Section 213(d) of the Internal
Revenue Code; they include expenditures for a spouse and dependents, even if they are not
eligible to have an HSA themselves. IRS publication 502, Medical and Dental Expenses,
provides a good overview. The principal purpose of Section 213(d) is to describe which
expenses may be taken into account in determining the itemized deduction for medical
expenses. However, qualified medical expenses under section 213(d) also include over-the-
counter medicines (i.e., medicines available without a prescription), for which a deduction
is not allowed.
¹⁸ The IRS considers payments for long-term care insurance to be qualified expenses even
if the HSA is funded through a salary reduction agreement under a cafeteria plan,
notwithstanding the explicit provision in Section 125(f) of the Internal Revenue Code
prohibiting cafeteria plans from including long-term care insurance; the rationale is that it
is the HSA that is paying for the insurance, not the cafeteria plan.

There is no time limit on when HSA withdrawals are made to pay (or reimburse
payments for) qualified expenses, provided adequate records are kept. However,
HSAs may not be used to pay expenses incurred before the HSA was established.
HSA withdrawals are not subject to nondiscrimination provisions applying to
self-insured medical reimbursement plans.
What Happens to HSAs at Death?
If a surviving spouse is the designated beneficiary of an HSA, it becomes an
HSA for that widow or widower.
If someone other than a surviving spouse is the designated beneficiary, the HSA
is terminated as of the date of death and the fair market value becomes taxable income
to that person.¹⁹ If there is no designated beneficiary, the remaining assets become
part of the estate and the fair market value becomes taxable income to the deceased
individual on the final return. In these instances, amounts included in gross income
are reduced by qualified expenses incurred by the deceased before death and paid
within one year.
What Administrative Provisions Apply to HSAs?
The IRS has proposed model forms that banks, insurance companies, and other
approved entities can use as trust or custodial agreements with eligible individuals.
The proposed agreements, which are not mandatory, provide a safe harbor definition
of these institutions’ responsibilities. Among other things, the proposed forms clarify
that trustees and custodians may rely on account owners’ representations about their
age, that they are covered by a HDHP, and that their contributions do not exceed the
maximum allowed.²⁰ In addition, the proposed forms state that trustees and custodians
are not responsible for determining whether distributions are used for medical
expenses.
HSA funds may be invested in investments approved for IRAs, such as bank
accounts, annuities, certificates of deposit, stocks, mutual funds, and bonds. However,
trustees and custodians need not make available all of these options. There is no
requirement that funds be invested in vehicles that do not lose value. HSA funds may
not be invested in life insurance contracts or most collectibles (i.e., tangible property).
Administration and account maintenance fees may be withdrawn from the HSA
(in which case they will not be considered taxable income) or paid separately (in
which case they will not be taken into account with respect to contribution limits).

¹⁹ This rule applies even if the non-spouse designated beneficiary is someone whose medical
expenses could have been paid from the account (such as a dependent child).
²⁰ However, trustees and custodians may not accept contributions that exceed the annually-
adjusted dollar amounts (e.g., $2,850 and $5,650) and allowable catch-up contributions.

Trustees and custodians may place reasonable restrictions on the frequency and
minimum amount of HSA distributions.
Are HSAs Covered by ERISA?
The Employee Retirement Income Security Act (ERISA) establishes
requirements for employee benefit plans. Among other things, it establishes reporting,
disclosure, and fiduciary standards for employers, superceding state laws on these
matters. Benefit plans with minimal employer involvement are exempted.
The U.S. Department of Labor (DOL) has determined that HSAs generally will
not be considered ERISA plans, even if employers open and make contributions to the
employees’ accounts, provided employer involvement is otherwise limited.²¹ For the
exemption to apply, employers must not limit employees’ ability to move funds to
another HSA, impose additional conditions on using HSA funds, make or influence
investment decisions regarding HSAs, represent that HSAs are employee welfare
benefit plans established by the employer, or receive any payment or compensation
in connection with HSAs.
The DOL has also determined that certain cash contributions offered by HSA
trustees or custodians as an incentive to establish an HSA are not a prohibited
transaction under ERISA.²²
What State Requirements Apply to HSAs ?
States do not have to approve HSAs for them to become available within their
jurisdictions. However, individuals cannot establish or make contributions to HSAs
unless they have a qualifying HDHP. States might not allow the sale of insurance that
meets the conditions for these plans if they require all insurance to include certain
benefits with no or low deductibles and if those benefits do not fall within the IRS
definition of preventive benefits. The IRS granted a waiver until January 1, 2006, that
temporarily allowed insurance in these states to be considered HDHPs, giving the
states time to change their laws.
This regulatory barrier does not apply to employers that self-insure since ERISA²³
generally exempts their plans from state insurance mandates. It does apply to
employers that purchase insurance from insurance companies as well as to insurance
that is sold in the individual market and small group market.

²¹ Department of Labor, Field Assistance Bulletin 2004-1 (April 7, 2004) and Field
Assistance Bulletin 2006-02 (October 27, 2006).
²² Department of Labor Advisory Opinion 2004-09A, December 22, 2004.
²³ For additional information, see CRS Report RS20315, ERISA Regulation of Health Plans:
Fact Sheet, by Hinda Chaikind.

What Are the Administration’s Current Proposals?
The President’s FY2009 budget includes a number of proposals regarding HSAs.
All of them would require modifications to current statutory language:²⁴
^!allow health plans with 50% coinsurance to qualify as high deductible
health plans,
^!allow any medical expense incurred on or after the first day of HSA
eligibility to be considered a qualified expense, even if incurred
before the HSA is established,
^!allow larger contributions from employers for chronically ill persons,
^!allow family coverage to include coverage where each individual can
receive benefits once they have reached the minimum deductible for
an individual,
^!allow both spouses who are eligible individuals to contribute the
catch-up contribution to a single HSA owned by one spouse, and
^!allow contributions to HSAs to be made by individuals covered by an
FSA or HRA, but offset the maximum allowable HSA contribution
by the level of FSA or HRA coverage.
Conclusion
As of September 2008, nearly all the rules needed to implement HSAs have been
issued. However, as HSAs become more common and new health plan arrangements
emerge, additional questions are arising, prompting the need for further guidance.
At some point, Congress may want to consider whether changes to HSA rules are
warranted in light of information about who has them and how much is in their
accounts. Consideration might also be given to what role, if any, HSAs have in
proposals to reduce the number of the uninsured and to implement other health care
reforms.

²⁴ For more information, see the Department of the Treasury’s General Explanations of the
Administration’s Fiscal Year 2009 Revenue Proposals (February, 2008) p. 25-26.