As Congress considers repealing the Affordable Care Act, political observers have begun to consider the legislative programs being touted as replacement programs. At the forefront of consideration is the concept of a health savings account (HSA), which is a tax-advantaged account, tied to a high-deductible health plan, which can be used to pay for certain medical expenses.

HSA Concept

The concept of HSAs began in the early 1970s, when health care costs began to rise faster than inflation. Policy experts theorized that if patients paid their own medical expenses, then the cost of health care would decrease as patients would become price conscious. The idea of HSAs gained serious attention during the 1993 – 1994 debate over President Clinton’s health care plan, which was a proposal for total government control of the health care industry. Those opposed to the Clinton plan countered with HSAs as an alternative. After the Clinton plan was defeated, HSAs did not come up for debate again until a decade later, when they were established as part of the Medicare Prescription Drug, Improvement, and Modernization Act, which was signed into law by President George W. Bush on Dec. 8, 2003.

According to the law, Americans could establish an HSA for themselves as individuals or as an account with larger contribution limits covering medical expenses for their family. Contributions made via payroll deposits (through an employer) are typically made with pre-tax dollars, which means they are not subject to federal income taxes, and funds withdrawn from the account remain tax-free if used for medical expenses. Funds in an HSA are separate from insurance coverage and remain available for the account holder for future qualified medical expenses even after a change in insurance plan or employment status.

Reform Proposals

In the coming year, HSAs will be a major focus as Congressional leaders are likely to repeal the Affordable Care Act and devise a replacement program to cover the 20 million Americans who received coverage through the legislation. While the 115th Congress and the Trump administration have yet to formally unveil their proposed legislation, some initial proposals have been publicized. President Trump has proposed that HSAs “would become part of the estate of the individual and could be passed on to heirs without fear of any death penalty.” Currently, there is no tax penalty for HSAs inherited from a spouse, but those inherited from someone other than a spouse are included in an heir’s income.

Also, observers believe that Speaker Paul Ryan’s A Better Way health care policy paper, which was unveiled June 22, 2016, will be the foundation for reform efforts. Speaker Ryan’s proposal advocates for broad expansion of HSAs by increasing the maximum out-of-pocket contribution to $6,550 for an individual and $13,100 for a family. The proposal also would allow spouses to make catch-up contributions to the same HSA account and permit qualified medical expenses incurred before HSA-qualified coverage begins to be reimbursed from an HSA as long as the account is established within 60 days. Additionally, it would authorize HSAs for the Indian Health Service beneficiaries and also dependents of military personnel who utilize TRICARE. In addition to Speaker Ryan’s plan, a growing number of other Republican ACA replacement proposals also feature HSAs in various ways. For instance, the Republican proposal, American Health Care Reform Act of 2017, would allow states to provide HSA-style accounts for Medicaid beneficiaries.

HSA Growth

Over the last several years, HSA investments have continued to grow. An important aspect of HSAs is that they have annual contribution limits; in 2017, the limit for individuals rose to $3,400 from $3,350, while the family limit stayed the same at $6,750. A recent report detailed that the number of HSA accounts has risen to 16.7 million, holding almost $30.2 billion in assets, a year-over-year increase of 25 percent for HSA assets and 22 percent for accounts for the period of Dec. 31, 2014 to Dec. 31, 2015. The report also projects that by the end of 2018, the HSA market will exceed $50 billion in HSA assets held among almost 30 million accounts.

HSA Advantages

One of the advantages of an HSA is that it is not “use it or lose it.” An individual’s balance can continue to grow year after year. In fact, one could wait for decades before using the funds in an HSA. In addition, an HSA balance can be invested in mutual funds, which can offer lower cost index funds as investment options.

Also, an HSA can be set-up with any qualified trustee or custodian. A number of individuals or their families are choosing to open HSAs with a provider that is different from their insurance company to take advantage of lower fees and establish independence in the event that they change insurance providers. Furthermore, an HSA can provide retirement benefits. An individual who has not exhausted their HSA balance can use their account similar to a traditional IRA. Distributions can be made from an HSA for non-medical expenses. These distributions will be taxed, just like a traditional IRA. For those 65 and older, however, there is no 20-percent penalty levied. However, one needs to be 65 years or older to avoid the penalty, not the 59 ½ years, which applies to IRA and 401k accounts. HSA funds also can be passed on as part of a will or general inheritance.

Although the specific HSA components in a future replacement bill have yet to be determined, policy advisers have said to be on the watch for private-sector approaches serving as a model.