Health Savings Accounts (HSA)


In an effort to respond to the rising cost of health insurance, many employers have made use of tax-favored accounts such as health flexible spending accounts (health FSAs), health reimbursement arrangements (HRAs) and health savings accounts (HSAs) to offer consumer-driven health plans.

This article will provide answers to commonly asked questions related to HSAs. It highlights guidance issued by the Treasury Department and Internal Revenue Service (IRS), as well as recent legislation, from 2003 through 2012.

 What is a Health Savings Account?   

An HSA is a tax-exempt trust or custodial account established for the purpose of paying qualified medical expenses. HSAs are much like Archer Medical Savings Accounts (MSAs)[1], but the rules applicable to HSAs are less restrictive.

An HSA can be a powerful tax savings tool for paying qualified medical expenses. In general, HSA contributions made by an eligible individual are deductible and employer HSA contributions made on behalf of an eligible employee are excluded from the employee’s gross income. Interest and other earnings on HSA contributions accumulate tax-free. Amounts distributed from an HSA for qualified medical expenses are generally tax-free as well.

Keep in mind that some states define income differently than the IRS. As a result, HSAs that are tax-exempt at the federal level may not be tax-exempt at the state level.

Who can establish an HSA?

An individual may contribute to an HSA in any month in which he or she is:

  • Covered under a high deductible health plan (HDHP) on the first day of the month;
  • Not also covered by another health plan that is not an HDHP (with certain exceptions);[2]
  • Not entitled to benefits under Medicare;[3] and
  • Not eligible to be claimed as a dependent on another person’s tax return.

Self-employed individuals can be eligible to establish an HSA.

What expenses are eligible for tax-free reimbursement from an HSA?

An HSA may reimburse qualified medical expenses incurred by the account beneficiary and his or her spouse and dependents.

Effective for plan years beginning on or after Sept. 23, 2010, group health plans and health insurance issuers providing dependent coverage of children must make coverage available for adult children up to age 26. The federal tax laws were changed, effective March 30, 2010, to allow an employee participating in a group health plan, cafeteria plan, FSA or HRA to exclude from his or her gross income the value of coverage and reimbursements provided for an adult child who is under age 27 at the end of the employee’s tax year. This change does not apply to HSAs.  Thus, to qualify as a dependent child for HSA tax-free reimbursement purposes, the age limit is generally 19, if the dependent is not a full-time student. If the dependent is a full-time student, the age limit is generally 24.

Distributions made from an HSA to reimburse the account beneficiary for qualified medical expenses are excluded from gross income for federal tax purposes. Qualified medical expenses are defined within IRC Sec. 213(d).

In addition to qualified medical expenses, the following insurance premiums may be reimbursed from an HSA:

  • COBRA premiums;
  • Health insurance premiums while receiving unemployment benefits;
  • Qualified long-term care premiums;[4] and
  • Any health insurance premiums paid, other than for a Medicare supplemental policy, by individuals age 65 and over.

What expenses are not eligible for tax-free reimbursement from an HSA?

The following expenses may not be reimbursed from an HSA on a tax-advantaged basis:

  • Premiums for Medicare supplemental policies;
  • Expenses covered by another insurance plan;
  • Expenses incurred prior to the date the HSA was established; or
  • Any expenses other than qualified medical expenses and the HSA reimbursable premiums described above.

As of Jan. 1, 2011, over-the-counter drugs purchased without a prescription are no longer qualified medical expenses for reimbursement from an HSA, except insulin.

Can ineligible expenses be reimbursed from an HSA?

Yes. The trustee is not required to determine if a claim submitted for reimbursement is a qualifying medical expense. The amount withdrawn from an HSA for a non-qualifying medical expense is added to the account beneficiary’s income and subject to a 20 percent penalty, or a 10 percent penalty for distributions that occurred before Jan. 1, 2011. If funds are distributed as a result of the account beneficiary’s death, disability or after he or she is eligible for Medicare, the 20 percent penalty does not apply.

What is a high-deductible health plan (HDHP)?

As explained above, to be HSA-eligible, an individual must be covered under an HDHP and not have any other type of impermissible health coverage. An HDHP is a plan that satisfies the applicable minimum annual deductible and maximum annual out-of-pocket requirements noted below.


High-Deductible Health Plan (HDHP)
Type of Coverage Minimum Annual Deductible Maximum Annual Out of Pocket Expenses
Individual $1,200 $6,050
Family $2,400 $12,100

Amounts for 2012

As an exception to the minimum annual deductible requirement, an HDHP may provide coverage for preventive care (as defined by the IRS) subject to a lower deductible or no deductible.

How must an HDHP administer the deductible under a family plan?           

In addition to establishing minimum annual deductibles for HDHPs, the IRS has also set forth rules governing how the deductible is to be administered.

Many health plans that are not HDHPs administer family coverage in a way that includes “stacking the deductible” or an “embedded deductible.” A plan that stacks deductibles or has an embedded deductible pays claims for a specific individual if he or she has met the individual deductible, even if the family as a whole has not met the family deductible.


Susan, Bob and their dependent elected family coverage under an HDHP. The plan year begins on Jan. 1 and includes a $1,200 individual deductible and a $2,400 family deductible. Susan incurs $2,000 in medical expenses on Jan. 15. Since the plan has an embedded deductible, Susan is required to pay $1,200 and the plan pays the remaining $800. Although the family deductible was not met, the plan will pay claims for Susan after she has met the individual deductible.

Under the IRS rules, this plan does not qualify as an HDHP since claims were paid before the $2,400 HSA-required family deductible was met.


Susan, Bob and their dependent elected family coverage under an HDHP. The plan year begins on Jan. 1 and includes a $2,400 individual deductible and a $5,200 family deductible. Susan incurs $3,000 in medical expenses on Jan. 15. Since the plan has an embedded deductible, Susan is required to pay $2,400 and the plan pays the remaining $600. Although the plan’s family deductible was not met, the plan will pay claims for Susan after she has met the individual deductible.

In this example, the plan complies with the IRS rules and qualifies as an HDHP. The plan includes an embedded deductible, but its minimum individual deductible is equal to the minimum HSA-required family deductible.

An HDHP is not required to include, or prohibited from including, an embedded or stacked deductible. If it does, however, it must comply with the minimum annual deductible requirements explained here.

What is preventive care?

On March 30, 2004, the IRS clarified that preventive care includes, but is not limited to, the following:

  • Periodic health examinations, including tests and diagnostic procedures ordered in connection with routine examinations, such as annual physicals;
  • Routine prenatal and well-child care;
  • Child and adult immunizations;
  • Obesity weight loss programs;
  • Screening services[5]; and
  • Tobacco cessation.

Preventive care does not generally include any service or benefit intended to treat an existing illness, injury or condition.

The IRS provided temporary transitional relief for individuals in states where HDHPs were not available because state laws required fully-insured health plans to provide certain benefits at levels not permitted under an HDHP. For example, some state laws define preventive care more broadly than the IRS. IRS guidance clarified that for purposes of HSAs and corresponding HDHPs, the IRS (not the state) definition of preventive care governs. In order to provide states with time to modify their laws to accommodate HDHPs, the IRS began enforcing its definition requirement after Dec. 31, 2006.

According to America’s Health Insurance Plan’s (AHIP) Center for Policy and Research 2007 survey, “100 percent [of HSA/HDHP plans offering first-dollar coverage for preventive care outside plan deductibles] cover adult and child immunizations, well-baby and well-child care, mammography, Pap tests and annual physical exams. Nearly 90 percent of policies purchased first-dollar coverage for prostate cancer screenings and more than 80 percent offered this coverage for colonoscopies.” Preventive screenings may also include newborn screenings, children’s vision tests, adult blood pressure and cholesterol tests, women’s bone density testing, colorectal cancer screening, prostate cancer screening for men over 50 and adult screening for depression.

Under health care reform, non-grandfathered group health plans and health insurance issuers are required to provide coverage for preventive care on a “first dollar basis” (that is, without any co-pays, deductibles or other cost sharing), effective for plan years beginning on or after Sept. 23, 2010. Health care reform’s definition of “preventive care” is different from the IRS’s definition of “preventive care” for HSA eligibility purposes. It seems likely, however, that the IRS will interpret “preventive care” for HSA eligibility purposes to include health care reform’s preventive care mandate.

Can preventive care include prescription drugs?     

Yes. Prescription drugs or medication are preventive care when taken by a person who has risk factors for a disease but is asymptomatic or to prevent the reoccurrence of a disease from which a person has recovered. While HDHPs may cover some prescription drugs like any other preventive care or service, determining on a case-by-case basis whether a prescription drug is taken preventively or to treat an existing condition may be problematic for processors of claims. The IRS also does not consider drugs to be preventive if they “treat an existing illness, injury or condition.” Since it is not always decipherable if medication is taken as a preventive measure, most HSA/HDHP plans do not include prescription drugs as a preventive benefit.

Must prescription drug benefits be subject to the deductible?

Yes. Except for prescription drugs that are preventive care, prescription drug benefits covered under an HDHP must be subject to the overall plan deductible. An individual that is covered by an HDHP and a separate prescription drug plan that provides prescription drug benefits after a small copayment is not eligible to contribute to an HSA.

Who can contribute to an HSA?

As clarified in IRS Notice 2004-50, any person, including but not limited to the account holder, an employer or a family member, may make contributions to an HSA on behalf of an eligible individual.

Unlike MSAs, the employer and employee may both contribute to the HSA in the same year, subject to annual contribution limits. However, if an employer makes contributions to any employee’s HSA, the employer must make comparable contributions (that is, the same dollar amount or the same percentage of the HDHP deductible) to the HSAs of all comparable participating employees. “Comparable participating employees” are eligible individuals who are in the same category of employees (current full time, current part time or former employees) and who have the same category of HDHP coverage (self only, self plus one, self plus two or self plus three or more). For the purposes of making a contribution to the HSA of an employee who is not a highly compensated employee (as defined by the IRS), highly compensated employees are not treated as comparable participating employees.

An employer may allow employees to contribute pre-tax dollars to the HSA through a Section 125 plan. IRS Notice 2004-50 clarifies that matching contributions made by an employer through a cafeteria plan are not subject to the comparability rule.  However, the employer’s contributions are subject to the nondiscrimination rules governing cafeteria plans (i.e., eligibility rules, contributions and benefits tests, and key employee concentration tests). An employer considering matching employee contributions should consult with its cafeteria plan administrator or legal counsel to ensure compliance with these nondiscrimination rules.

Can an individual make contributions to an HSA when they are also covered under an FSA or HRA?     

It depends on the type of FSA or HRA. IRS guidance released on May 11, 2004, clarifies how an individual’s participation in an HSA can be coordinated with coverage under an FSA or HRA. The IRS sets forth four examples of acceptable plans in which an individual can participate and still contribute to an HSA:

  • Limited-purpose FSA or HRA;
  • Post-deductible FSA or HRA;
  • Suspended HRA; and
  • Retirement HRA.

What is a Limited-purpose FSA or HRA?     

A Limited-purpose FSA or HRA pays or reimburses Section 213(d) medical expenses that are “permitted coverage” (e.g., dental, vision). For example, an individual that is covered under an HDHP and a Limited Purpose FSA continues to be eligible to contribute to an HSA where the FSA only pays or reimburses expenses for dental or vision care not reimbursed by any other source.

What is a Post-deductible FSA or HRA?       

A Post-deductible FSA or HRA pays or reimburses medical expenses incurred after the individual has met the minimum annual deductible within the HDHP. For example, an individual may seek reimbursement for amounts paid as copayments or coinsurance, after he or she has met the deductible. Note, however, that funds within an FSA are subject to the use-it-or-lose-it rule. Therefore, in general, an individual will forfeit contributions made to their FSA if they do not meet the deductible during the year.

What is a Suspended HRA?         

A Suspended HRA, pursuant to an election made before the beginning of the HRA coverage period, does not pay or reimburse at any time, any medical expenses incurred during the suspension period, except preventive care or “permitted coverage.” Once the suspension period ends, the individual is no longer eligible to contribute to an HSA because he or she is entitled to receive Section 213(d) medical expenses from the HRA.

What is a Retirement HRA?         

A Retirement HRA pays or reimburses medical expenses incurred after the individual retires. After retirement, the individual is no longer eligible to contribute to an HSA.

Can an individual be eligible to contribute to an HSA if they are also covered under an Employee Assistance Plan (EAP)?    

Yes.  An individual will not fail to be eligible to contribute to an HSA merely because the individual is also covered under an EAP, disease management program or wellness program if the program does not provide significant benefits in the nature of medical care or treatment. An example within IRS Notice 2004-50 clarifies that the availability of short-term counseling, including but not limited to substance abuse, alcoholism, mental health or emotional disorders, does not provide significant benefits in the nature of medical care or treatment.

Can an individual be eligible to contribute to an HSA if they also purchase a discount card?       

Yes. On July 23, 2004, the IRS clarified that an individual’s purchase of a discount card does not disqualify him or her from being eligible to contribute to an HSA. The individual must be required to pay for the cost of the services, less the discount, until the deductible is met. For example, an individual may purchase a discount card to purchase prescription drugs or vision care or services.

Can an individual be eligible to contribute to an HSA if he or she participates in an FSA with a grace period?

It depends. In IRS Notice 2005-86, the IRS clarified the interaction between the FSA grace period and eligibility to contribute to an HSA. Later legislation and IRS Notice 2007-22 amended this relationship further. In general, coverage by a general purpose health FSA with a grace period would disqualify an individual from contributing to an HSA during the FSA’s grace period, unless the employee had a zero balance in the FSA at the end of the plan year. An FSA can also be amended to allow HSA contributions. Notices 2005-86, 2007-22 and statutory changes made at the end of 2006 provide further guidance regarding participants’ HSA eligibility during the cafeteria plan grace period.

How much can an individual contribute to an HSA?

For each month an eligible individual is covered under an HDHP, he or she may contribute one-twelfth of $3,150 for individual coverage or $6,250 for family coverage for calendar year 2012. An eligible individual who enrolls in an HSA after the beginning of the plan year is permitted to make a full year’s contribution provided the individual remains covered by the HDHP for at least the 12-month period following that year, except for death or disability.

Further, HSA contributions do not have to be made in equal amounts each month.  An eligible individual can contribute in a lump sum or in any amounts or frequency he or she wishes. However, an account trustee/custodian (bank, credit union, insurer, etc.) can impose minimum deposit and balance requirements.

The HSA contribution limit is reduced by any contributions made to an MSA in the same year. Rollover contributions from another HSA or MSA can be accepted. These rollover contributions are not subject to the annual contribution limit. Additionally, certain one-time rollover contributions from an FSA, HRA or IRA may also be made under statutorily specified conditions.

Individuals who are age 55 or older by the end of the tax year are permitted to make “catch-up contributions”, contributing up to an additional $1,000 annually.

Who can administer an HSA?

On Aug. 10, 2004, the IRS revised Notice 2004-50 to clarify that insurance companies, banks, or similar financial institutions that have received IRS approval to be a trustee or custodian may administer HSAs. Any other person or organization already approved by the IRS to be a trustee or custodian of IRAs or MSAs is automatically approved to also be an HSA trustee or custodian. Unless an employer applies for IRS approval, it may not self-administer an HSA.

Notice 2008-59 further clarifies that any administrative and maintenance fees charged by a trustee or custodian and withdrawn from the HSA are not to be reported as distributions from such HSA. The fair market value of the HSA at the end of the taxable year should also be reduced by the amount of such withdrawn fees.

What are the differences between HSAs, HRAs, FSAs and MSAs?

The attached chart provides a comparison among these tax-favored accounts.

Where can I find more information on HSAs?

To find consumer-friendly information released by the IRS on HSAs, please visit:

HSAs may not be the right solution for all employers or individuals. Please contact your Benefit Logic representative for assistance in determining what tax-advantaged account will best meet your goals.

Benefit Logic welcomes the opportunity to help your organization examine its plan design(s) and make recommendations for improvement.

[1] Because the Archer MSA pilot program terminated at the end of 2007, the current availability of Archer MSAs is limited. Effective Jan. 1, 2008, Archer MSA contributions may be made or received only by eligible employees who previously made or received MSA contributions or by eligible employees of certain Archer MSA participating employers.


[2] For example, accident, dental, vision, long-term care, specific conditions (i.e., cancer only policies), and hospital indemnity plans.


[3] Mere eligibility for Medicare does not make an individual ineligible to contribute to an HSA. An employee who continues to work after attaining age 65 may continue to contribute to an HSA so long as he or she has not enrolled in Medicare. IRS Notice 2004-50


[4] HSAs may reimburse expenses for qualified long-term care premiums, even where contributions are made by employees with pre-tax dollars through a cafeteria plan. While HSAs may pay or reimburse qualified long-term care premiums, the exclusion from gross income is limited to the adjusted amounts under IRC 213(d)(10).


[5] IRS Rev. Ruling 2004-23 clarifies that the screening services for the following conditions are included within the definition of preventive care: cancer, heart and vascular diseases, infectious diseases, mental health conditions and substance abuse, metabolic, nutritional, and endocrine conditions, musculoskeletal disorders, obstetric and gynecologic conditions, pediatric conditions, and vision and hearing disorders.