What is a Health Savings Account (HSA)? An Health Savings Account (HSA) is a special tax-advantaged savings account similar to a traditional Individual Retirement Account (IRA) but designated for medical expenses. An HSA allows you to pay for current covered health care expenses and save for future qualified medical and retiree health care expenses on a tax-favored basis.
HSAs provide triple-tax advantages: contributions, investment earnings, and qualified distributions all are exempt from federal income tax, FICA (Social Security and Medicare) tax and state income taxes (for most states).
Unused HSA dollars roll over from year to year, making HSAs a convenient and easy way to save and invest for future medical expenses. You own your HSA at all times and can take it with you when you change medical plans, change jobs or retire. This means the funds in the account [both yours and your employer's, if they contribute] are non-forfeitable and portable.
Funds in the account not needed for near term expenses may be invested, providing the opportunity for funds to grow. Investment options include money market accounts, mutual funds, etc.
To be eligible to set up an HSA and to make annual contributions, you must be covered by a qualified “high deductible health plan”, or HDHP.
How does an HSA work? To be eligible to contribute to an HSA, you must be covered by a qualified high deductible health plan (HDHP) and have no other first dollar coverage.
You may use your HSA to help pay for medical expenses covered under a high-deductible health plan, as well as for other common qualified medical expenses.
HSA funds unused remain in your account for later, and can be invested in a choice of investment options, providing the opportunity for funds to grow.
HSAs work in conjunction with a HDHP. All the money you (or your employer) deposit into your HSA up to the maximum annual contribution limit is 100% tax-deductible for federal income tax, FICA (Social Security and Medicare) tax, and in most states, state income tax. This makes HSA dollars tax-free.
You can use these tax-free dollars to pay for expenses covered under your HDHP until you have met your deductible. The insurance company pays covered medical expenses above your deductible, except for any coinsurance; you can pay coinsurance costs with tax-free money from your HSA. In addition, you can use tax-free dollars for qualified medical expenses not covered by the HDHP, such as dental, vision and alternative medicines.
The funds in the account also can be used for other, non-medical expenses, but then your dollars are subject to ordinary tax, plus a 10% penalty if you are under age 65. The 10% penalty does not apply if the distribution occurs after you reach age 65, become disabled or die; however ordinary income tax may still apply.
Funds remaining in your account at year-end are yours to rollover and accumulate for your future healthcare expenses. You may choose not to spend your HSA dollars on small expenses, instead using after-tax dollars to meet these expenses, and leaving your HSA dollars to grow for future needs. Choosing the expenses on which to spend your HSA dollars and which to pay out-of-pocket with after-tax dollars is entirely up to you.
What is the value of an HSA? I can choose a lower-deductible plan without an HSA. Why should I choose a high deductible plan and have to pay for what is covered by the other health plan until I meet that higher deductible?
First, consider the following: unless you have a significant, catastrophic-type medical claim, it is unlikely that you will recoup the amount of money you pay in employee contributions for traditional plans (such as a PPO) or even Health Reimbursement Accounts (HRAs).
For example, assume you contribute $550 a month for family coverage, which amounts to $6,600 per year (12 x $550). We’ll come back to this figure.
Now, if your family has three doctor visits during the year at $200 each ($600 total), plus four prescriptions at an average of $75 ($300 total), that's a total of covered expenses for the year of $900. Assuming the co-payments for each of the three doctor visits was $20 (3 x $20 = $60) and each of the four prescriptions was $30 (4 x $30 = $120), you will pay $180 out of pocket, taxed.
Now let’s look at the whole picture. Your insurance paid for $720 of your $900 in costs. You paid $180 — taxed — along with $6,600 in contributions.
Compare the numbers of your available plans, and you’re likely to find that an HDHP and HSA make sense for you. The HDHP usually offers lower premiums in exchange for the higher deductible, including the same coverage for significant health expenses as with the more expensive traditional plans. You pay for costs below the deductible with tax-free dollars and employer contributions, if offered, and keep and grow the funds you don’t use each year.
How much can you save over time? An enrollee with family coverage who contributes the maximum allowed each year could accumulate a balance over $300,000, assuming he/she invests and receives an annual investment return of 7%. And this assumes the accountholder is using their HSA to pay medical expenses of $1,500 per year!
What happens to my HSA if I quit my job or otherwise leave my employer? Your HSA is portable. This means that you can take your HSA with you when you leave and continue to use the funds you have accumulated. Funds left in your account continue to grow tax-free. If you are covered by a qualified HDHP, you can even continue to make tax-free contributions to your HSA.
What health care expenses does my HSA cover? Your HSA funds can be used tax-free to pay for out-of-pocket qualified medical expenses, even if the expenses are not covered by your HDHP. This includes expenses incurred by your family.
There are hundreds of qualified medical expenses, including many you might not expect: over-the-counter medications; dental visits; orthodontics; glasses; long-term care insurance premiums; cost of COBRA coverage; medical insurance premiums while receiving federal or state unemployment compensation and post age-65 premiums for coverage other than Medigap or Medicare supplemental plans. In addition, HSA funds may be used to pay your Medicare parts A and B premiums and for employer-sponsored retiree plans.
All of these expenses may be paid for with your HSA funds, free from federal taxes or state tax (for most states).
Refer to IRS Publication 502 for a more complete list of qualified medical expenses.
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