Health Savings Accounts (HSAs) are a way that people can pay for unreimbursed medical expenses such as deductibles, co-payments, and services not covered by insurance. Eligible individuals can establish and fund these accounts only when they have a qualifying high-deductible health plan (HDHP). This means insurance with a deductible of at least $1,350 for individual coverage and $2,700 for family coverage (2018 figures) and no other health plan to draw on, although there are some exceptions.
There are also tax advantages that can be substantial for some people: 1) contributions are deductible (or excluded from income that is taxable if made by an employer); 2) withdrawals are not taxed if used for medical expenses; 3) earnings on the savings account earnings are tax-exempt; 4) unspent balances may accumulate without a maximum limit.
What is an HSA?
An HSA is a tax-exempt savings account opened for the express purpose of paying qualified medical expenses of the account owner. Accounts may be established with banks and insurance companies or with other entities approved by the IRS to hold Individual Retirement Accounts (IRAs) or Medical Savings Accounts (MSAs).
HSAs are just that, savings accounts. As long as funds are saved and spent on qualified medical expenses, all contributions, capital gains, and withdrawals remain untaxed. And like many other bank accounts, HSAs come complete with debit cards and checks.
Insurance companies that offer qualified high deductible health plans (HDHPs) often also establish HSAs for their policyholders. However, there is no government requirement that HSAs be established by the institution that provides the health plan. Individuals interested in establishing an HSA must locate an entity that accepts the accounts; they cannot simply call an ordinary savings account an HSA.
Who can have an HSA?
Individuals are able to set up and contribute to an HSA if they have a qualifying HDHP and no disqualifying coverage. For example:
- Individuals cannot be enrolled in Medicare, which generally occurs at age 65.
- Individuals must not be able to be claimed as a dependent on another person's tax return. However, they can keep their HSAs once they become ineligible.
- Individual family members may have their own HSAs, provided they each meet the eligibility rules. They can also be covered through the HSA of someone else in the family; for example, a husband may use his HSA to pay expenses of his spouse even though she has her own HSA.
How can I find an HSA?
A good place to start looking is www.ehealthinsurance.com where you'll find a list of policies available by state.
What makes an HSA a good idea?
As an HSA owner you'll likely do better than break even each year if you are in good health. With the savings on your insurance premiums, you should be able to accumulate a sizeable nest egg. And, unlike flexible spending accounts (FSAs), HSA funds are not subject to a "use it or lose it" policy. Anything you don't spend one year carries over to the next year. After all, it's your money. Your HSA funds may be put into investments approved for IRAs, such as bank accounts, annuities, certificates of deposit, stocks, mutual funds, and bonds.
What is a high-deductible health plan?
It's a health plan with a minimum deductible. For individual coverage, the annual deductible in 2018 is at least $1,350; for family coverage, it must be at least $2,700. These amounts will be adjusted for inflation and rounded to the nearest $50 in future years.
For individual coverage, the annual limit on out-of-pocket expenditures for covered benefits is $6,650 in 2018. For family policies, the limit must not exceed $13,300. These amounts will also be adjusted for inflation and rounded to the nearest $50 in future years.
How are contributions handled?
As with IRAs, contributions to HSAs must be made in cash. Employees can make contributions through cafeteria plan salary reduction agreements. These are plans established by employers under which employees accept a lower take-home pay in exchange for the difference being deposited into their accounts.
How much may be contributed to an HSA?
Two types of contributions may be made to HSAs: regular and catch-up. The annual contribution limit for an HSA for individual coverage is $3,450 in 2018. The annual limit for family coverage is $6,900. For individuals between 55 and 64, additional "catch-up" contributions to an HSA are allowed—$1,000 in 2018. The maximum contribution limits will be adjusted for inflation in future years, rounded to the nearest $50.
What happens to an HSA when you leave your employer?
Nothing - No matter how many times you change employers, your account is fully portable. Account owners are immediately fully vested. All contributions made by an employer belong to the account holder.
What is the tax treatment of HSA contributions and withdrawals?
Individuals who contribute to HSAs may claim a deduction on their federal income tax return. It is an "above the line" deduction, which means that the deduction for HSA contributions is used in determining adjusted gross income (AGI). Thus, it may be taken by all eligible taxpayers, whether they itemize deductions or take the standard deduction. Contributions made by employers are excluded from gross income of employees in determining their income tax liability. Withdrawals from HSAs are exempt from federal income taxes if used for qualified medical expenses. Those dollars not used for qualified medical expenses are included in gross income on your federal income tax form and are also subject to a 20% penalty tax. The penalty is waived in cases of disability or death and for individuals age 65 and older. After age 65, the money can be used without penalty for non-medical purposes.
What happens should an account owner die?
At death, if a surviving spouse is the designated beneficiary of an HSA, it becomes a HSA for that widow or widower. If someone other than a surviving spouse is the designated beneficiary, the HSA is terminated as of the date of death and the fair market value becomes taxable income to that person. If there is no designated beneficiary, the remaining assets become part of the deceased's estate.
Health Savings Account (HSA) advantages are:
- Pretax money is used to fund them; withdrawals are tax-free.
- Money can be invested in a variety of financial products, such as mutual funds and stocks, and contributions can be rolled over from year to year.
Health Savings Account (HSA) disadvantages are:
- You must enroll in a health plan with a high deductible and high out-of-pocket maximum expenses to open one.
- Penalties and taxes are assessed if a HSA is not used for health care expenses.
- 2018 Annual Limits. Relating to Financial Planning (2018). Denver: College for Financial Planning.
- Health Savings Accounts (HSAs) (2014). Washington DC: U.S. Department of the Treasury.
- IRS Sets 2018 HAS Contribution Limits (2018). Society for Human Resource Management.
Written By: Patricia Q. Brennan, CFP®, Senior Extension Trainer, Rutgers New Jersey Agricultural Experiment Station (NJAES) Cooperative Extension of Morris County
Updated By: Barbara O'Neill, Ph.D., CFP®, Extension Specialist in Financial Resource Management