Update to the “Medicare Prescription Drug, Improvement, and Modernization Act of 2003”

The Treasury Department and IRS recently announced a ruling confirming that an individual can be eligible to contribute to a Health Savings Account (HSA) even if his/her spouse has non-qualifying family coverage, provided the spouse's coverage does not cover the individual. In addition, the ruling clarifies how much the eligible spouse can contribute to an HSA in such a situation. The spouse with the HSA may contribute the same amount annually to the HSA as any other individual--$2,000 for individual coverage and $5,000 for family coverage.

Section 223(b)(5) of the tax code provides special rules for married individuals. In general, if either spouse has family coverage, both spouses are treated as having only such family coverage. If each spouse has family coverage under different health plans, both spouses are treated as having family coverage under the plan with the lowest deductible.

But if a spouse has HDHP family coverage and the other spouse has non-HDHP self-only coverage, the spouse with the HDHP family coverage is an eligible individual and may contribute to an HSA up to the amount of the annual contribution limit.

For example, Steve and Mary Jones are married with three children. Steve has a low deductible family health plan that covers him and the Jones children. His plan does not qualify for an HSA. The ruling clarifies that Mary, who is not covered under Steve's family plan, may have her own separate high-deductible health plan that does qualify for an HSA.

A copy of the ruling may be viewed at:
http://www.treas.gov/press/releases/reports/rr200525.pdf

Medicare Prescription Drug, Improvement, and Modernization Act of 2003

Okay, so we didn’t get the LTCI tax incentives this year … or did we?

The new Medicare bill has provided a way for any American with a high-deductible health insurance plan to pay for some or all of LTC insurance premium with pre-tax dollars.

That’s great news, isn’t it? Basically, Section 1201 of the new Medicare Drug Bill, Public Law No. 108-173, added Section 223 to the Internal Revenue Code to permit eligible individuals to establish Health Savings Accounts (HSA’s) for taxable years beginning with 2004. This new law improves upon Medical Savings Accounts in three significant areas:

1) Instead of being offered only to self-employed or to employees of businesses with 50 or fewer employees, the new Health Savings Accounts are available to anyone with a deductible of at least $1,000 up to $2,600 for an individual plan with annual out-of-pocket expenses (deductibles, co-payments, not premiums) not exceeding $5,000 (Family plans: at least a $2,000 deductible up to $5,150 and out-of-pocket max of $10,000); and

2) Medical Savings Accounts allowed the account holder to deposit a portion of the health insurance deductible and HSA’s allow 100% of the deductible to be deposited.

3) Unlike MSA’s, contributions to HSA’s may be made by or on behalf of eligible individuals even if the individuals have no compensation or if the contributions exceed their compensation.

Like Medical Savings Accounts, any unused amounts at the end of the year in HSA’s are allowed to grow tax-deferred, which is much better than the “use it or lose it” feature of a flexible spending account. (In case you are wondering as I did, the above deductible amounts were trended forward to account for inflation, in case you read the original law that states up to $2,250 for individuals and up to $4,500 for families.)

People who own MSA’s may keep them and also set up an HSA, or they may roll over the MSA balance into an HSA. They may want to do the rollover, because if they keep the MSA, the annual contribution limit to the HSA is reduced by their MSA contribution for the year.

Here is a summary of this exciting new legislation:

Americans who have high-deductible health insurance plans (HDHPs) in the amounts specified above may deposit 100% of their health insurance deductible in a pre-tax account and may use that money to pay for any IRS-approved medical expense. See this webpage for a list of IRS-approved medical expenses: http://www.ltcconsultants.com/general/articles/IRS_app_med_expenses.pdf plus three types of insurance premium: COBRA premium, health insurance premium only if the applicant is receiving unemployment, and qualified long-term care insurance premium.

In addition, individuals over 65 may use HSA dollars to pay premiums for Medicare Part A or B, Medicare HMO, premium for employer-sponsored health insurance (including retiree health insurance), but not Medicare supplement premiums. (Note: Americans who are eligible for Medicare can’t set up a Health Savings Account, but if they set one up prior to becoming eligible for Medicare, they can keep it – they just can’t make new contributions after becoming Medicare-eligible.)

To encourage saving for health expenses after retirement, HSA owners between age 55 and 65 are allowed to make additional catch-up contributions to their HSA’s as follows: $500 in 2004; $600 in 2005; $700 in 2006; $800 in 2007; $900 in 2008 and $1,000 in 2009 and thereafter. In a family plan, both spouses may do the catch-up amount if both are between ages 55-65.

“Qualified” LTCI premium means the age-based amounts per Section 213d (10) (A) of HIPAA (the Health Insurance Portability and Accountability Act of 1996).

The 2004 amounts are:

The catch-up provision for ages 55-65 will be especially helpful as the age-based LTCI premium could easily exceed their health insurance deductible. The catch-up provision allows them to supplement that amount and help them pay as much premium as possible with pre-tax dollars.

Self-employed people were given the ability to pay the age-based amount of LTCI premium with pre-tax dollars in 2003 when the health insurance deduction on Form 1040 went to 100%. This meant that 100% of the age-based amount of LTCI premium could be included on that line and their taxable income is lowered by that amount. The new Medicare drug bill gives that capability to all Americans with a high-deductible health insurance plan.

In a nutshell, both categories (self-employed and anyone with a high-deductible health insurance plan) have the same tax incentive contained in the proposed House bill 2096 and Senate bill 1335 (i.e. they can pay the age-based amount of LTCI premium with pre-tax dollars, which really means they’re getting a premium discount).

Funds can be used at age 65 without penalty. Prior to age 65, a 10% penalty is levied for funds withdrawn other than for an acceptable medical expense.

At any age, HSA funds used for any reason other than qualified medical expenses will be included in gross income.

Also, employers can contribute to employee HSA’s and employer contributions are not subject to FICA taxes. Individuals and family members who contribute to an HSA may do so whether or not they itemize their taxes. Finally, employers with cafeteria plans can allow employees to contribute pre-tax dollars to an HSA through a salary reduction plan. (Note: This creates an exception to the rule that LTCI premium can’t be part of a cafeteria plan, but this is the only exception for that.)

HSA’s do not have to be established with the same provider of the high-deductible health insurance plan. Any insurance company or any bank can be an HSA trustee or custodian. Any other entity already approved to provide IRAs or MSAs is automatically approved to offer HSA’s.

A few additional points about HSA’s:

• One can’t set up an HSA is he/she is eligible for another health plan that is not a high-deductible plan.
• If either spouse has family coverage, the HSA becomes a family HSA. The contribution limit is determined by the spouse with the lower deductible (ex. Bob’s deductible is $3,000 and Mary’s is $2,000, so the limit for both of them is $2,000).
• If each spouse has individual coverage, they each may set up an HSA and contribute the amount of their respective deductibles (ex. Bob and Mary have individual coverage. Bob’s deductible is $1,500 and Mary’s is $1,000. They each set up an HSA and Bob contributes $1,500 to his and Mary contributes $1,000 to hers).
• Each spouse between the ages of 55 and 65 may contribute an additional $500 in 2004 according to the catch-up provision.
• Contribution limits are determined on a monthly basis based on how many months of the year the person is covered by a HDHP. If the person’s HDHP coverage begins July 1 with a $1,000 deductible, only $500 can be deposited for that year ($1,000/12 = $83.33 x 6).
• Even though the contribution limit is determined on a monthly basis, it can be paid anytime during the year and up-to-the-date taxes must be filed (i.e. April 15th, so the HSA account holder really has five quarters in which to make the contribution, like an IRA).
• In the case of a network health insurance plan, it’s okay if the out-of-network out-of-pocket maximum exceeds the HSA out-of-pocket limit.
• Any expense paid through an HSA can’t also count as a medical expense toward the 7 _% threshold for tax purposes.
• The IRS will issue appropriate forms for the taxpayer, similar to Form 8853 for MSA’s, to be filed with the annual tax return to report HSA account activity for the year.

As I discussed in my response to the November Consumer Reports article, the 2000 NAIC Model Regulation is having a huge impact on the LTCI industry. As states pass this legislation or something similar, insurance companies are introducing new products with higher premiums. Why? Because this legislation requires actuaries to certify that the premiums aren’t ever expected to increase, and if they do increase, the insurance company can only keep 15% of each rate increase dollar for administrative costs, instead of 40% before this legislation passed. Actuaries are conservative, so it’s no surprise they want the premiums high enough to be able to provide that certification comfortably.

The timing of Health Savings Accounts is GREAT. By providing a premium discount with pre-tax dollars, HSA’s can be used as a tool to offset the higher premiums that we are seeing due to the NAIC regulation.

Of course, the real answer is to sells LOTS more LTCI and spread the risk. As we do so, premiums can come back down. You may remember the ACLI study that said 60% of Americans ages 35+ can afford a three-year benefit period and 40% can afford a six-year benefit period, both with using only 2% of income.

I believe that if everyone bought even a three-year benefit period, LTCI could save our economy in the first half of this century by keeping the baby boomers off Medicaid. I believe the Partnership Plans have proven this is possible.

In the last decade since the Partnership Plans have been in existence in Connecticut, New York, Indiana and California, less than 100 people have exhausted their LTCI benefits and accessed Medicaid. Hopefully legislation proposed by Rep. John Peterson of Connecticut will pass. This will restore the capability of the rest of the states to offer a Partnership program in the near future. This legislation will make it possible once again for assets to be sheltered after death for those who purchase a Partnership policy, just as it works in the four states named above. (The 1993 budget bill changed the Partnership so that any new states that implemented it could only allow policyholders to shelter assets while they were alive; a very unpopular idea.) Or, the government could just say that all benefits from all TQ policies will provide a dollar-for-dollar offset for assets when someone applies for Medicaid.

For additional information, the IRS website has an overview as well as a Q&A section on HSA’s: http://www.treasury.gov/press/releases/js1061.htm.

Okay, got to go set up my HSA to replace my "use it or lose it" medical reimbursement account!

Phyllis Shelton is President of LTC Consultants, a Nashville-based company that has trained over 40,000 agents via web (www.ltcuniversity.com) or live training and delivered 2,020 education meetings for the FLTCIP. She is also the author of Long-Term Care: Your Financial Planning Guide, April 2003 and can be reached through www.ltcconsultants.com.

Note: On March 30, 2004 the Treasury Department and the Internal Revenue Service issued guidance that supplements that issued in December 2003. The March guidance provides:

• A preventive care safe harbor definition
• That prescription drugs may not be provided without the high deductible
• Transitional relief through 2006 for individuals covered by both a high deductible health plan and a separate prescription drug plan
• Transitional relief for medical expense reimbursements incurred after the establishment of a high deductible health plan but before the establishment of an HSA on or before April 15, 2005.

Further regulations will be released in June by the Treasury Dept. and the IRS, hopefully to clarify key outstanding issues, such as the interaction between HSAs and other arrangements that employers may currently offer, including flexible spending accounts (FSAs) and health care reimbursement arrangements (HRAs), as well as the ability of employers to make matching contributions to HSAs.

An April, 2004 bulletin from the Department of Labor said that HSA’s are not subject to ERISA even if employers contribute to the premium. DOL went on to say HSA’s really represent personal health care savings accounts vs. traditional health insurance. However this is still true even if employers contribute to the premium. This clarification is expected to spur the growing movement for employers to offer HSAA’s. www.kilpatrickstockton.com/publications/legal_alerts.aspx