HSA for December 16, 2017

How Health Savings Accounts Work

Small business owners, self-employed individuals and those without access to a workplace health plan have long been caught on the horns of a dilemma: For quality health insurance to be affordable, you need to set a fairly high deductible. On the other hand, the IRS taxes money you save, making it more difficult to set aside enough money to handle medical expenses you have to pay for out of your own pocket.

Congress took note, and some years ago introduced a measure designed to give tax relief to those faced with that problem: the health savings account.

The health savings account, or HSA, allows you to defer taxes on any money you contribute, in order to cover out-of-pocket medical expenses. There is a catch, however: To qualify for an HSA, you must also own a qualified high-deductible health plan, or HDHP.

High-Deductible Health Plans Explained
HDHPs are major medical policies with higher deductibles than normally found in regular medical plans. These plans aren’t designed to provide full coverage for every little sniffle or stubbed toe. Instead, these plans are designed to keep premiums low by restricting coverage to major medical events. The consumer retains the risk of smaller, less severe or less expensive medical conditions.

HSA/HDHPs vs. Flexible Spending Accounts
You may be familiar with Flexible Spending Accounts. These plans – generally included in Section 125, or “cafeteria” employ benefits plans, also allow you to set aside money on a tax-advantaged basis to pay for medical expenses. However, with a Flexible Spending Account, you are under a “use it or lose it” restriction: If you don’t spend the money by the end of the year, the assets become the property of the employer.
HSAs, on the other hand, accumulate from year to year, compounding (hopefully, depending on your investment allocation within the account.)

HSA and HDHP Eligibility
Not just anyone can contribute to an HSA. To be eligible, you must own a high-deductible health plan. You must also not be covered by any other health plan, nor enrolled in Medicare. Finally, you cannot be claimed as a dependent on someone else’s tax return. The IRS considers you eligible for an HSA all year long if you were eligible on December 1st of the previous year. However, a special “testing period” may apply if there are any changes in your eligibility status. We cover HSA eligibility in detail here.

Minimum and Maximum Deductible Levels
In order to qualify to contribute to an HSA, your high deductible health plan must meet certain criteria. For policies covering only yourself, with no family coverage, the annual deductible must be at least $1,200, as of 2011. The maximum annual deductible and other out-of-pocket expenses cannot be more than $5,950. The max limit, however, doesn’t apply to expenses or deductions for out-of-network services if your plan uses a network, which is the rule with health maintenance organizations (HMOs) and preferred provider organizations (PPOs). The limits apply only to in-network charges.
For family coverage, the minimum annual deductible is $2,400 for individual plans, and $11,900 for family plans. Your state may impose more restrictive limits on HDHPs.

Preventive Care
In some cases, your HDHP may provide for some preventative care without applying a deductible. This may apply to tests, checkups, mammograms and diagnostic procedures ordered as follow-ups to routine examinations.

HSA Contribution Limits And Taxation
Congress sets limits on the amount you can contribute to an HSA in any given year. Under current law (late 2010, as this rules are written), the contribution limit for an HSA for 2012 is $3,100, and the limit for families is $6,250. Those aged 55 or over can contribute an additional $1,000 per year. Currently, the base contribution limits are indexed to inflation, but not the 55+ catch-up contribution limit. If you contribute too much, you will be liable for a 6 percent excise tax on the overage.

Contributions are tax deductible, and all growth in an HSA is tax-deferred. If you withdraw the money to pay for a bona fide medical expense, the amount withdrawn is tax free. However, any withdraws you make to pay non-qualified expenses, or for any other reason other than medical expenses, is taxable as ordinary income, and subject to a 10 percent penalty.

Caution: As of 2011, purchases of over-the-counter medications are no longer qualified medical expenses for HSA purchases. This is a change from 2010 and previous years. If you have questions, see some answers here.

You can only contribute cash to an HSA. You cannot contribute property, such as securities. But you can roll assets held in an HSA over into a new HSA, with no tax liability. There is no upper limit to rollovers – only to new HSA contributions. You can contribute for tax year 2011 until April 15th of the following year (though you can only contribute a maximum of $3,050 or $6,150 for 2011, depending on whether you are contributing as an individual or for a family.)

Claiming the Deduction
To claim a deduction for a health savings account contribution, fill out an IRS form 8889, Health Savings Accounts, and submit it to the IRS along with your personal income tax return. You must use a Form 1040 or, if you are a non-resident of the United States, a 1040NR to claim the deduction; you cannot claim the deduction if you file using a Form 1040-EZ or a 1040A.

For complete information on health savings accounts, see IRS Publication 969.