Health savings accounts (HSA) were created so you could save money to pay for out-of-pocket healthcare expenses. HSAs work with high-deductible insurance plans.
When you sign up for a high-deductible plan, you will tell your company how much money to withhold from each paycheck and put in your HSA. Your employer may contribute money as well. If you’re self-employed, you can set up an HSA through your bank.
HSAs have many advantages.
You’ll get a triple tax break. All of the money you and your employer contribute is exempt from federal income tax, reducing your overall tax bill, and employer contributions don’t count as income. Your money will gain tax-deferred interest. Finally, you don’t pay taxes on any amount you use to pay for qualified medical expenses.
These accounts let you plan for medical expenses. You can use the money to pay for deductibles, copays, coinsurance, and prescription drugs (but not your monthly insurance premium). Moreover, the limit on the amount you contribute, in general, mirrors the caps on individual and family deductibles of many high-deductible health insurance plans.
They also let you plan for the future. Your account will never expire, and, with the tax savings, an HSA can work like an Individual Retirement Account (IRA), where you put away tax-deferred money to use after you retire.
For 2016, you can contribute up to $3,350 to an HSA for yourself, and $6,750 for your family. If you’re between 55 and 65, you can save an extra $1,000.
Unlike with flexible spending accounts, where at the end of the year you lose any unspent money you set aside for healthcare expenses, you can roll over your HSA balance each year.
You can change the amount you put into an HSA at any time during the year, as long as you don’t go over the federal annual limit. You’ll probably be using a debit card to pay for health expenses, but you can also request checks for healthcare providers who won’t take a card.
There are some caveats.
You can’t contribute to an HSA if you’re covered under another plan, such as Medicare, a preferred provider organization, or a health maintenance organization. You also can’t be a dependent on someone else’s health plan.
The Internal Revenue Service (IRS) prohibits people 65 and older from contributing to an HSA. After age 65, however, you can withdraw the money for nonmedical expenses without a tax penalty. Be aware that the IRS will tax your withdrawals as income, like an IRA.
You have to be careful how you spend the money. While prescription drugs are qualified expenses, over-the-counter medicines, like aspirin, are not. The IRS decides which expenses are qualified and unqualified.
If you spend money from your HSA on something that’s not a healthcare expense, the IRS will catch you. When you file your tax return, the IRS will fine you 20 percent of the cost of the non-qualified expense and add your withdrawal to your gross income – to tax it again. You may even set yourself up for an audit.
September 28, 2015
Christopher Nystuen, MD, MBA