Benefits of An HSA

By now, most people have heard the term HSA or Health Savings Account.  But what is it?  A Health Savings Account combines a high deductible health insurance plan with a tax savings account. It operates somewhat like a Flexible Spending Account.  An FSA allows for pretax income to be redirected into an employer-sponsored plan with limitations placed upon it by the employer, but not exceeding $2,600, and does not require a high-deductible health plan to be attached to it.  This plan reimburses you for qualified medical expenses.  The main drawback to an FSA is that it requires that you utilize the funds in the given calendar year.  You are not allowed to carry over the excess into the next year, with limited exceptions.

An HSA also allows you to contribute pre-tax income to an employer-sponsored plan or make an after-tax dollars deductible contribution to an HSA that you set up yourself.  Unlike an FSA, there is no limit to the amount that can be carried over to another year.  You are also the owner of the account, which can generate interest or be invested, much like an IRA.  HSAs do not carry a phaseout limitation, and so are available to high-earners and low-earners alike.  HSA users must carry a high-deductible health plan.  For many self-employed individuals, small business owners, and employees, the deductible threshold won’t be a problem.  It is also okay if the insurance plan doesn’t impose deductibles for preventative care, such as annual checkups.  An individual cannot be eligible for Medicare benefits, even if they are not utilizing them, or be claimed as a dependent on another person’s tax return.

Eligible individuals can make a tax-deductible contribution of $3,450 for individual plans, $6,900 for a family plan, and those over fifty-five years of age can add an additional $1,000.  The contribution for any particular tax year can be made as late as April 15th of the following year.  Since the deduction goes on the front of the federal individual tax return, Form 1040, it is not limited by the ability to take itemized deductions.  It does not count against self-employment tax bills, however.  Any employer contribution is made with pretax dollars.  This means that it is exempt from federal income, Social Security, Medicare and unemployment taxes.  It cannot be taken as a deduction on the personal return.

HSAs can be set up at any bank, insurance company or IRS deemed institution.  It must be for the exclusive use of paying the medical bills of the plan’s beneficiary, spouse and dependents (if a family plan).  Health insurance premiums do not qualify.

When you think of tax-advantaged investment vehicles, most people think of 401(k) plans, retirement accounts, and 529 plans.  The thought on HSAs is that it is usually just a form of health plan assistance.  Many taxpayers are unaware of the triple tax benefit of an HSA:  pre-tax contributions, tax-free earnings and tax-free withdrawals.  The HSA allows the account owner to pay for current and future health care expenses with either pre-tax dollars or tax-deductible dollars.  Even if the contribution is made by the employer, the money within it belongs to the account owner.  The interest earned on an HSA is tax-free.  And you may withdraw the funds tax-free for use to pay qualified medical expenses.

When they are discussed, HSAs are primarily thought of as a tax shelter.  They are also a good vehicle for putting aside money.  With the rising cost of health care plans, more and more companies are shifting health care costs away from the employer and onto the worker.  With this shift, more and more individuals are becoming eligible for an HSA.  If a taxpayer can contribute the maximum amount annually to an HSA, and have very little health costs during the year, it can very easily become a savings vehicle.  Tax strategists suggest that when health costs do arise, utilizing your current income to pay off the expense instead of the HSA allows it to grow tax-free, while getting the benefit of the current deduction.  Additionally, as we age, health expense costs increase, and having access to an HSA after retirement can be extremely beneficial.

In having the HSA act as a savings account, it ends up working very similarly to a Roth IRA.  Both have after-tax contributions, tax-free earning and no required minimum distributions after age seventy and one-half.  For this reason, one tax strategy that is utilized in funding an HSA is with a transfer from an IRA.  A taxpayer can make a tax-free rollover from an IRA to an HSA once in their lifetime.  The rollover contribution is limited to the maximum allowable contribution for the year, minus any amount already contributed.   There is a penalty on distributions not for medical purposes of twenty percent before age 65, and no penalty after.  To be tax-free, the distributions must be for qualified medical purposes regardless of age.  In the future, if the taxpayer determines that the HSA is no longer needed, they can transfer the money to their retirement accounts, tax free.

In summary, an HSA can be a great choice for taxpayers wishing to reduce their upfront health care costs, with the added benefit of saving for the future.  With HSAs coupling with high-deductible health plans, the monthly premiums are generally lower than with low deductible plans.  HSAs also allow you to pay for medical items with pre-tax dollars that other insurance options often don’t cover, or make a contribution with post-tax dollars and the taxpayer receives a tax deduction on their return.  The unused funds can be carried over from year to year, making the HSA a viable savings account.  As with everything, HSAs aren’t for everyone.  If a high-deductible plan seems risky, or you know that you will have significant health care expenses in the near future, a lower deductible plan may be better for you.  If you are in a lower income bracket or paying no taxes at all, there is little advantage to stocking away thousands of dollars.  Once you reach age 65 and qualify for Medicare, it is possible that your HSA withdrawals will become taxable.  Transaction fees associated with the account may also need to be taken into consideration.  Take a look at your plan options and associated costs, compare health savings accounts to flexible spending accounts, and see what works best for you.