2013 marks the ten-year anniversary of the approval of Health Savings Accounts, or HSAs, by congress. These medical savings plans can be powerful tools in either an individual or family health-funding strategy. With the Affordable Care Act’s requirement that all US citizens obtain health care starting in 2014, it’s more important than ever to understand how HSAs work and to find out if they might be a good idea for you.
What is an HSA?
HSAs are special accounts that are set up to help individuals pay for qualified medical expenses (see below). Contributions to these accounts can be made either by individuals or employers. Funds that are placed into the account are tax-deductible and, if the money withdrawn from the account is used to pay for qualified medical expenses, it is tax exempt. While the money is in the account, it can be invested, and any earnings accrued are likewise exempt from taxes. HSAs must be established in conjunction with high deductible health plans (HDHP) and to set one up, you must not be covered by another health insurance plan, be someone else’s dependent, or be enrolled in Medicare.
What is a high deductible health plan?
As you might imagine, an HDHP is a regular health insurance policy with a high deductible (the amount of money you must pay out-of-pocket before your insurance provides reimbursement).
A major benefit of a plan like this is that the monthly premiums tend to be quite low, especially when compared to plans with lower deductibles. When combined with an HSA, the plan makes sense because you can use the money in your HSA account to pay for health services up to your deductible, at which point your insurance kicks in. For 2013, the IRS has set the minimum deductible amounts for an HDHP at $1200 for an individual or $1400 for a family, and the maximum out-of-pocket amounts (which come from paying deductibles, co-payments and amounts other than the plan premiums) at $6250 for individuals or $12,500 for families.
Another benefit of HDHPs is that many cover preventative care (such as routine physicals and gynecological exams) in full even before you reach your deductible.
How much can I contribute to an HSA?
For 2013, the IRS has set individual HSA contributions at $3,250 for individuals and $6450 for families. If you are over age 55, you are able to place an additional $1000 per year into the account through what’s known as a “catch-up contribution.”
Can I leave the money in my HSA from year to year?
Yes. Think of your HSA as a regular savings account. In fact, you are even able to place some of the funds in your HSA into investments like stocks, mutual funds and bonds. The earnings from those investments fall under the same tax-advantaged privileges as all the rest of the money in the account.
Can I set up one HSA for both my wife and myself?
No. Like an IRA, you both must have separate accounts. Your insurance plan, however, can be a family plan in both of your names.
OK, so I can use my HSA to pay for qualified medical expenses. What are those?
For the most part, any reasonable medical expense is considered “qualified.” Doctor visits, surgery, prescription drugs, eye glasses and eye exams, dental treatment and x-rays and much more is included. Even some over-the-counter drugs can be paid for using your HSA, providing you first obtain a doctor’s prescription for them. Some common expenses that are NOT considered qualified medical expenses include health club memberships, cosmetic surgery, specialty foods and beverages, funeral expenses, and weight loss programs. To find the most recent list of all qualified medical expenses, download IRS Publication 502 here.
What if I want to use the money in my HSA for something other than medical expenses?
If you are under 65 and withdraw money from your HSA for something other than a qualified medical expense, you will pay tax on the money based on your regular tax bracket PLUS you will have to pay an additional 20 percent penalty. After age 65, there is no penalty for withdrawing the funds for any reason. You only need to pay tax on the money as you would with all ordinary income. After 65, you may also use the funds in your HSA to cover some insurance premiums like Medicare Part A and B, and Medicare HMO.
INVEST WISELY. If you are going to invest some of the money in your HSA, be sure to pick conservative investments like CDs, money market accounts and bonds. Your gains may not be as large as with stocks or mutual funds, but the cash in your HSA is there primarily to safeguard your healthcare, not to make you rich, so you won’t want to gamble it on volatile investments. Save that for other types of investment vehicles, like your IRA.
BEWARE OF FEES. Just like mutual funds, annuities and other types of investments, HSAs can charge you fees that can add up in hurry. Shop around and make sure you ask about set-up fees, charges for debit cards and checks, and charges for transactions.
KEEP YOUR RECEIPTS. Be sure to keep good records for all your qualified medical expenses to provide your accountant at year’s end.
CHOOSE YOUR HDHP WISELY. If you are relatively young, healthy, and not on any medications, you may want to choose an HDHP plan with the highest allowable deductible so that your monthly premiums are as low as possible. However, if you have a chronic condition that requires frequent doctor visits and prescription medication, you might choose higher monthly premiums so that your insurance will kick in after you’ve met lower deductibles.