HSAs can be a great benefit to employees in good health. Assuming the funds in the HSA aren’t needed for medical or related expenses, these accounts are a way for employees to actually put some money aside for retirement.
And remember their other appeal for employers: They don’t have to approve medical expenses or sort through accounts, as with FSAs.
1. Are HSAs the same nationwide or do state laws apply?
HSAs were created by the United States Congress and are available to taxpayers in all fifty states.
Based in federal law, the HSA laws and rules are the same across the country for most issues.
State laws apply in a number of key areas such as: whether state income tax applies, when an HSA is deemed “established,” the types of health insurance available, in some instances whether the HSA is protected from creditors, and a number of other less common situations.
Federal authorities, especially the Internal Revenue Service (IRS), have provided much of the regulation and guidance on the federal HSA law.
Section 502 of the proposed Health Savings Act of 2016 would provide equivalent bankruptcy protections for HSAs as individual retirement accounts.
2. Are there disadvantages of an HSA?
Yes. But first, some background: For an individual unable to afford traditional insurance, the High Deductible Health Plan (HDHP) and HSA combination may provide an affordable approach to insurance not possible otherwise.
Many people that can afford traditional insurance also choose HDHPs and HSAs because the combination reflects a cost savings and provides more pure insurance rather than prepaid medical.
This background is important because many of the disadvantages of HSAs are only in comparison to traditional health insurance, low or no deductible health insurance.
The following are potential disadvantages of a combination HDHP and HSA.
• More Responsibility for Health Care Spending. HSAs require individuals to take charge of their own health care spending. This will generally require more time devoted to learning about health care costs and alternatives than a person with traditional insurance coverage undertakes where much of the expense is simply paid.
• Tax Reporting. HSA owners are required to account for both HSA contributions and distributions each year on their income tax return. Plus, the HSA owner needs to save medical receipts.
• HSA Rules. HSAs, similar to all tax-driven types of accounts, can get complex. The HSA owner is responsible to learn the HSA rules and follow them or face tax consequences.
• HSA Maintenance. The HSA owner is responsible to maintain the HSA: pay medical bills, monitor the balance, choose beneficiaries, and otherwise maintain the HSA.
• Higher Deductible. An HSA owner faces a higher health insurance deductible than a person with traditional insurance and may need to pay that larger deductible amount. This can be an increased cost burden (although lower deductibles generally mean higher premiums, which also can be a burden).
• Expenses before Savings. An HSA owner may face a large medical expense prior to having time to build a sufficient balance in the HSA.
• Taxable Withdrawals. Withdrawing funds from an HSA for other than qualified medical expenses makes the withdrawal taxable and subject to a 20 percent penalty (unless aged sixty-five or older)
• Incentive to Avoid Medical Treatment. Because HSA owners must pay for medical care below the deductible amount (an important exception applies for preventative care), HSA owners may not seek medical treatment when it is appropriate to do so. This could increase medical expenses overall if the condition intensifies.
3. Who is an HSA “owner”?
HSAs are individual accounts and must be established in the name and social security number of an individual.
The person opening the HSA is called the “HSA owner.”
Various other terms are also used to name the HSA owner, including the following: “account beneficiary,” “account owner,” “account holder,” “taxpayer,” and in certain contexts, “employee”.
4. What is an HSA “custodian”?
An HSA custodian or trustee is typically a financial institution or insurance company that opens and maintains HSAs on behalf of HSA owners.
HSA law requires that all HSA owners open and maintain their HSAs at an HSA custodian or trustee. Congress created the role of HSA custodian or trustee as an intermediary between the taxpayer and the tax-favored money contained within an HSA.
This intermediary role is important to the tax reporting integrity of HSAs. Only entities approved by the IRS can serve as HSA custodians or trustees. This requirement gives the IRS the ability to obtain tax reporting on HSA activity from the HSA custodian or trustee.
This third-party information reporting allows the IRS to triangulate its HSA reporting among the HSA owner, the HSA custodian and trustee and in some cases employer HSA reporting on the IRS Form W-2s.
The information reporting role is the key function of an HSA custodian or trustee. To satisfy that key role, the custodian must establish rules and procedures to properly account for all HSA contributions, distributions and gains in investments. (See also RC Section 223(d)(1)(B), IRS Form W-2.).
The custodian or trustee must also “administer the trust … consistent with the requirements of…” HSA law.
This includes using an HSA custodial agreement provided by the IRS or approved for use by the IRS.
Custodians must also follow numerous other rules imposed by HSA law including:
(1) not investing the assets in life insurance contracts,
(2) not commingling the assets with other property except in a common trust or common investment fund,
(3) and contracting that the balance in the HSA is nonforfeitable.
5. Are all insurance companies qualified to serve as HSA custodians?
No. Generally, only a life insurance company (defined in IRC Section. 816) can be an HSA trustee or custodian.
However, any entity can apply to be an approved custodian or trustee of HSAs.
6. What types of investments can a custodian offer?
HSA custodians are allowed to offer a wide range of investments including checking accounts, savings accounts, Certificates of Deposit, money market accounts, stocks, bonds, mutual funds as well as even more exotic choices.
7. Is an HSA custodian a fiduciary?
In most cases, an HSA custodian or trustee is not a fiduciary to the HSA owner.
A fiduciary is held to the highest standard of care and includes a duty of loyalty. Fiduciaries must put the best interests of their clients ahead of their own interests.
The legal duties imposed on the HSA custodian or trustee by the HSA laws are of a recordkeeping nature, not of a fiduciary nature.
The actual language in the custodial or trust agreement and the actual relationship between the parties can change this answer.
For most HSA custodians, it makes sense to avoid becoming a fiduciary as the responsibilities of the custodian generally would not require a fiduciary relationship and a fiduciary relationship imposes a greater liability risk.
Part of avoiding the fiduciary definition may include using the “custodial” agreement rather than the “trust” agreement to avoid the use of the word “trust” and its implied higher standard of duty.
HSAs run through trust departments or in cases where the financial institution intends to be a fiduciary are exceptions.
To avoid misunderstanding, financial institutions should add clear language to their custodial agreements outlining the duties of the custodian and specifically stating the custodian is not a fiduciary.
ERISA and the prohibited transaction rules define a fiduciary as follows.
“…means any person who (A) exercises any discretionary authority or discretionary control with respect to the management of such plan or exercises any authority or control with respect to the management or disposition of its assets, (B) renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so; or, (iii) has any discretionary responsibilities in the administration of such plan…”
In 2016, the DOL issued new fiduciary rules applicable to HSAs that makes HSA custodians fiduciaries if they provide investment advice or recommendations for a fee or other compensation with respect to assets.
Although the previous rule also potentially made HSA custodians fiduciaries if they provided investment advice, the new rule applies in a wider array of advice relationships. The new rules are designed to avoid conflicts of interest. (This topic is discussed in subsequent questions in the 2017 Health Savings Accounts Facts book in more detail -- click the image of the book cover to be taken to the National Underwriter site.)