My daughter started school around the time my third child was born, bringing home every virus known at the time. All three of my kids were constantly sick the entire school year. By the summer, my doctor’s office co-pays totaled over $500. I was still paying off my deductible from childbirth the previous year while trying to pay for doctor’s visits, co-pays, strep tests and chest x-rays. Many Americans find themselves in a similar situation. We are insured, thankfully, but still accrue a lengthy list of medical expenses even without the occurrence of a catastrophic medical event.
Congress provided some relief in 2003 with the passage of the Medicare Prescription Drug, Improvement and Modernization Act, which established the Health Savings Account (HSA) system as a means of saving money for future health expenses and allowing that money to grow tax-free.
You will be able to take advantage of an HSA if you participate in a High Deductible Health Plan (HDHP) either through an employer or your own individual plan. HDHPs are defined as plans with a minimum deductible of $1,200 for an individual or $2,400 for a family per year. Additionally, HDHPs are characterized as having a maximum out-of-pocket expense limit of $5,950 for an individual or $11,900 for a family per year. However, here’s a point to note. According to the Internal Revenue Service (IRS), out-of-network expenses cannot contribute to the total out-of-pocket expenses for the year. Only services through in-network providers count.
How HSAs Work
First, it’s important to note HSAs are completely different from the flexible medical spending accounts we have been familiar with for years. Flexible spending accounts traditionally had to be spent within the year or you lost your contributions. In most cases, they were just accounts to hold your tax-free money. HSAs, on the other hand, are structured like an IRA or 401K. Not only do unused funds rollover to the next year, but your money continues to grow and yield a return. When medical costs come up that are not covered by your insurance plan, you withdraw money to pay for qualified expenses. Use the money for dental work, prescriptions, co-pays, deductibles, eye care or many other qualified expenses. The IRS has a complete list of allowable expenses on their Web site. Depending on the account administrator, you may have access to funds via a debit card, special checks or a reimbursement process.
Benefits of an HSA
Here comes the good part. Establishing an HSA is a great way to defray the cost of medical expenses, but there are some other perks too.
- Contributed monies are taken before taxes, lowering your gross income and the amount of taxes you pay. If you happen to be unemployed, you can contribute money post-tax and take an “above the line deduction” on your IRS Form 1040. The result is the same, lower gross income.
- The funds withdrawn are tax-free. As long as you only make withdrawals for qualified medical expenses, you will not be taxed on the money withdrawn or the earnings of the account.
- All the money is yours. Some employers offer to contribute to your account. Once deposited, these funds become your personal property. Even if you change jobs, you keep the funds.
- You can use the money for other emergencies. Although you will be penalized just as you would for withdrawing early from a 401K, you can pay a penalty and taxes to use the money if needed.
- You can save money on health costs in the long run. If you are a fairly healthy person with a thriving HSA, you can choose an insurance plan offering a lower premium. These plans usually have higher deductibles and co-pays, but you can easily use your HSA to cover the costs. Instead of sending more money to an insurance company, you are putting more in your investment account. If you never need the money, it’s still yours. Conversely, if you never have a major medical crisis all the money you’ve invested in an insurance plan is lost.
- In the event you do have a major medical crisis, you are less likely to be left with a mountain of debt. High deductible plans usually cover 100 percent once the deductible is met. Even if you have a severe accident or require expensive treatment for a disease, combining an HSA with an HDHP will allow you to use the HSA to pay the deductible (assuming you’ve saved or earned that much) and the rest is paid by the insurance company.Restrictions and Rules
Similar to a retirement account, Health Savings Accounts are closely monitored by the IRS. Make sure your contributions and withdrawals are in compliance to avoid penalties.
- There are limits on contributions and they are unrelated to your income. Currently individuals can contribute $3,050 and families can deposit $6,150 per year. People over 55 are allowed an additional “catch up” contribution of $1,000.
- Withdrawing for non-medical expenses before the age of 65 will cost you. You will pay a 20 percent penalty plus income tax on the money you take out. Once you turn 65 you can avoid the penalty, but you’ll still be taxed if you use the funds for anything other than medical expenses.
- You cannot roll your HSA into another account, such as an IRA or 401K. You are allowed to transfer an IRA into an HSA, but only once.
- All activity to your account must be reported to the IRS. The bank handling your HSA will provide you with appropriate forms to complete your annual taxes.
How to Start an HSA
If your employer offers HSA benefits, you can ask your Human Resources representative for more information. The company may have a preferred bank. Otherwise, opening an account is as simple as visiting your bank. Most financial institutions will even allow you to apply online. You’ll need to have all your personal data available, including your health insurance plan information. From there, the bank will process your application and allow you to determine how to fund the account.