Health savings accounts (HSAs) are a growing trend in health care. An HSA is a tax-exempt savings account established for the purpose of paying for the qualified medical expenses of an individual and/or his or her spouse and tax dependents. HSAs are designed to provide eligible individuals with the following federal tax benefits:
- HSA contributions are tax-free.
- Interest and other earnings on HSA contributions accumulate tax-free.
- Amounts distributed from an HSA for qualified medical expenses are tax-free as well.
HSAs are offered in combination with qualified high deductible health plans (QHDHPs). The IRS sets forth the requirements a plan must meet to be considered qualified. These components include a minimum deductible, maximum out of pocket and no first dollar coverage. To be HSA-eligible, an individual must be covered under a qualified HDHP and not also covered by another health plan that is not an HDHP (with a few exceptions, including disability, dental care, vision care and long-term care insurance). This includes Medicare, Tricare, or any other medical plan. HDHPs generally have lower monthly premiums and higher deductibles than traditional health plans.
HSAs can cover medical expenses until the HDHP deductible is reached. The idea of this design is that the HSA pays for routine, smaller health expenses, while the HDHP offers protection in the event of a catastrophic medical expense, such as an unexpected illness, injury or hospitalization.
In general, money placed into an HSA can be withdrawn at any time. Any HSA withdrawal used for a purpose other than to pay for qualified medical expenses is taxable as income and subject to an additional 20 percent penalty. After an individual reaches age 65, HSA funds can be used for anything and the additional penalty tax does not apply. Because of this, we often see employees using this as an additional savings mechanism for retirement and HSA funds are often used for Medicare premiums.
Additional HSA Basics
- HSAs are controlled and owned by the individual or employee. HSA owners are responsible for annually reporting HSA contributions and distributions to the Internal Revenue Service (IRS) as an attachment to their IRS Form 1040 (U.S. Individual Income Tax Return).
- HSA contributions are non-taxable, and can be made by the HSA owner, an employer, a family member or any other person for months during which the owner is HSA-eligible.
- Annual limits apply to HSA contributions. The amount of the annual limit is federally mandated, and depends on whether the HSA owner has individual or family HDHP coverage.
- HSA funds, including interest and earnings, accumulate tax-free from year to year. HSAs are not subject to the “use it or lose it” rule applicable to health flexible spending accounts (FSAs). HSAs are portable, meaning individuals keep their HSAs even if they change jobs, change medical coverage or make other life changes.
- Even if an HSA owner is no longer HSA-eligible (for example, because the owner is no longer covered under an HDHP), he or she can still use accumulated HSA funds to pay for qualified medical expenses on a tax-free basis.
- HSAs are an inheritable asset. If a surviving spouse is the beneficiary, the spouse becomes the owner of the account and can use it as if it were his or her own HSA. For other beneficiaries, the account will no longer be treated as an HSA, and will pass to a beneficiary or become part of the deceased individual’s estate.
- HSAs can help individuals become better health care consumers by giving them more of a stake in controlling their health care costs. Since they are responsible for more out-of-pocket costs due to the higher deductible, many employees become more conscious of the health care dollars they are spending.
- HSAs are not for everyone. The decision of whether to choose HSA/HDHP coverage is different for each individual, and may depend on the predictability of health care costs. If an individual is generally healthy and/or has a reasonable idea of health care costs, then HSA/HDHP coverage may make more financial sense than traditional health plan coverage.
Please note that the information contained in this posting is designed to provide authoritative and accurate information, in regard to the subject matter covered. However, it is not provided as legal or tax advice and no representation is made as to the sufficiency for your specific company’s needs. This post should be reviewed by your legal counsel or tax consultant before use.