A Health Savings Account (HSA) is a “triple-tax-advantaged” medical savings account available to taxpayers enrolled in High-Deductible Health Plans (HDHP.) It allows taxpayers to use funds from the account to pay for certain qualified medical expenses.
An HSA is simply a special type of savings account that can be used to pay for qualified healthcare expenses. It is said to have a triple-tax advantage because, one, contributions made to the account are tax-deductible, two, the interest earned on the account is tax free, and, three, withdrawals from the account for qualified medical expenses are tax free.
In order to set up an HSA, taxpayers need to be enrolled in a HDHP. An HDHP is a health insurance plan that has a deductible of at least $1,300 in the case of an individual and at least $2,600 in the case of a family. Additionally, HDHP holders’ out-of-pocket expenses for the year (including deductibles, copayments, and coinsurance,) cannot exceed $6,550 in the case of individuals and $13,100 in the case of families (This limit does not apply to out-of-network services.)
Upon enrollment in an HDHP and the creation of an HSA, account holders will typically pay for their medical expenses without being reimbursed by their HDHP until they reach their annual deductible. When they pay for qualified medical expenses that aren’t covered by the HDHP, they may request tax-free distributions from their HSA to pay or be reimbursed for their expenses. If funds from the HSA are requested for non-qualified expenses, they will be subject to income tax and as well as an additional 20% penalty. Upon reaching the age of 65, however, the 20% penalty disappears.
In addition to the tax benefits, HSAs have additional benefits. Unlike flexible spending accounts, which allow holders to carry-over a maximum of $500 each year, HSAs have no limit on carry-overs or when the funds may be used.
While many people might be tempted by the ability to use HSA funds to pay current medical expenses without any tax consequences, the real benefit of an HSA comes from saving the HSA and allowing it accumulate interest tax-free. Doing so can allow holders to take greater advantage of the tax benefits and use the money later in life once the interest has appreciated and healthcare expenses are likely to be higher.
Those interested in investing larger amounts into their HSAs will need to be aware of the yearly contribution limits. For 2017, an individual may contribute up to $3,400 and a family may contribute up to $6,750 to their HSA. If you are an eligible individual who is age 55 or older at the end of your tax year, your contribution limit is increased by $1,000.
While there are many benefits to opening an HSA, there are several things people should think about before deciding to do so. When setting up an HSA, holders typically designate a beneficiary. If the beneficiary is your spouse, then the HSA automatically is treated as your spouse’s upon your death. However, if you don’t designate your spouse as the beneficiary, then the HSA ceases to exist upon your death and the fair market value of the HSA will be deemed taxable income to the beneficiary. Another thing to consider is that, with a HDHP, although your monthly premiums are lower, it can still be difficult to come up with enough money to meet the high deductible.
While the HSA clearly has many benefits, it is not necessarily for everyone. To determine whether it might be a good plan for you, consult with a trusted financial advisor.