By Carol H Cox
Photo: www.TaxCredits.net
The Health Savings Account (HSA) came into being as part of the Medicare Modernization Act of 2003. An HSA is designed to be used as a savings storehouse for medical expenses, current and future. The contributions to the HSA can be used to pay medical deductibles and out-of-pocket maximums in tandem with a High Deductible Health Plan (HDHP). You can open an HSA on your own once you are covered by an HDHP and meet other requirements, see below.
An HSA can also provide a nice tax-break and a tax-free means of saving for medical expenses in retirement. And the extent of contributions to an HSA isn’t limited by the contributor’s income tax bracket.
One of the beauties of an HSA is that, if you follow IRS rules, the money you place into the account is tax deductible and/or any money your employer contributes is excluded from your gross income. In addition to this, money you withdraw from the account (including any earnings from investments) used to pay for qualified medical expenses is also tax-free. If you can fully fund the account annually and resist using the money in the account until you retire, an HSA can grow to a sizable amount in a few years.
[If you know of another tax-advantaged account that has before-tax contributions, tax-free investment earnings, and tax-free withdrawals, please let me know!]
Of course, you can only use the money tax-free in the HSA to pay for qualified medical expenses, otherwise the money is subject to income tax and a 20 percent penalty. But money in the account can be invested and unused portions can be rollover from year to year.
You own the account, like an IRA, which means you keep the account no matter where you are employed or even not employed at all. To be eligible to contribute to an HSA you typically can’t have other health coverage besides your HDHP, can’t be enrolled in Medicare, and can’t be claimed as a dependent on some else’s tax return.
To be eligible to open and contribute to an HSA you must be covered by a HDHP. For 2016, an HDHP has the following annual deductible and out-of-pocket characteristics:
- Annual deductible of at least:
$1,300 for self-only coverage
$2,600 for family coverage
- Annual out-of-pocket medical expenses not exceeding:
$6,550 self-only coverage
$13,100 for family-coverage
(These amounts change annually, as they are indexed for inflation. Your insurance provider should be able to tell you if a plan qualifies as an HDHP.)
For 2016 the maximum contribution limit is $6,750 for family coverage and $3,350 for individual coverage. And if you are 55 years or older you can kick in an extra $1,000 because of the catch-up provision.
All in all it can be a pretty sweet tax-free savings vehicle, especially if you fully fund the HSA each year and leave most of the money in the account to accumulate and grow, year after year.
Of course, this would mean paying most or all of your medical deductibles and co-pays out of your own pocket, leaving your HSA alone to compound. But this may not be possible for many families—households need a sizable sum of money put aside to pay those high deductibles and co-pays from their own resources. Even still, if less than the full amount is left in the account from year to year, it could still provide a nice sum to use for medical expenses in retirement.
Once a person reaches age 65 and is enrolled in Medicare they are ineligible to make further contributions to an HSA, but he or she can still take distributions from the account tax-free to pay for some Medicare premiums, as well as qualified medical expenses. At age 65 or older, individuals can also make withdrawals for whatever they want. Although there will be no penalty fee, non qualifying withdrawals will be subject to income tax.
If you want to dig deeper into the rules and understand what are qualifying medical expenses and other requirements, see IRS Publication 969.
If any of you have used HDHPs and HSAs, please share your experiences with us.