The Ins and Outs of a Health Savings Account
What is a Health Savings Account (HSA)?
- An HSA is a tax-exempt trust or custodial account established and owned by an individual to pay for qualified medical expenses tax free. An HSA must always be combined with a qualified high-deductible health plan (HDHP).
- With an HSA there is no “use it or lose it” rule. The money will always belong to the owner of the account.
- HSAs were created through the Medicare Prescription Drug Improvement Act of 2003.
- An HSA offer the following tax savings:
- Contributions to the account are tax deductible.
- Withdrawals and earnings for qualified expenses are tax free.
- An HSA:
- Is portable.
- Can accrue interest (similar to an IRA).
- Is not required to be funded.
- Allows any balance to roll forward year after year.
What is a qualified HDHP?
- An HDHP is a health plan with the following characteristics:
- Requires a minimum deductible indexed annually for inflation.
- Requires a maximum out-of-pocket limit indexed annually for inflation.
- Provides first-dollar coverage for preventive care (no deductible or co-insurance).
- All covered benefits must apply to the plan’s deductible, including prescription drugs.
Who is eligible to establish an HSA?
- Must participate in an HDHP.
- Must not have health benefits from another health plan and not be covered by a spouse’s flexible spending account (FSA), unless it is a “limited purpose” FSA.
- Must not be eligible to be claimed as a dependent on another’s tax return.
- Must not be enrolled in Medicare.
- More than 2 percent shareholders in an S Corp., partners in a partnership, sole proprietors, and other self-employed individuals as long as they otherwise qualify.
Who can make contributions to an HSA?
- Anyone can make contributions anyone’s account, however it is important to note that the owner of the account receives the benefit of tax deductions.
- There are no income limits on those who contribute to the HSA.
- More than 2 percent shareholders in an S Corp., partners in a partnership, sole proprietors, and other self-employed individuals are not able to participate with pre-tax salary reduction contributions. Rules of attribution apply to more than 2 percent S owners, therefore the more than 2 percent owner’s spouse, parents, children, and grandchildren are also prohibited from contributing to the HSA on a pre-tax basis. However, the individuals described above can contribute on an after-tax basis and take an above-the-line deduction on his or her income tax return.
How much can be contributed to the HSA?
- The IRS sets an annual maximum that is indexed annually for inflation.
- For individuals age 55 and older, additional “catch up” contributions are allowed.
- Contributions may be made until April 15 of the following calendar year.
Advantages of an HSA
- Funds in the HSA account can be used to pay for current and future medical expenses, including expenses that insurance does not cover such as:
- COBRA premiums
- Medical expenses and insurance premiums during periods of unemployment
- Medical expenses during retirement entitlement
- Out-of-pocket expenses for Medicare, including premiums if consumer is age 65 or older (other than premiums for a Medicare supplemental policy)
- Qualified long-term care expenses and insurance premiums
- Tax advantages mentioned above
- Consumer decides:
- How much to contribute, if at all
- How much to use for qualified medical expenses
- Which medical expenses to pay with the account