What You Need to Know about Health Savings Accounts
Posted by: Candice Sopata | July 26, 2007
What Is an HSA?
Health Savings Accounts were created by a provision in the Medicare Prescription Drug Improvement and Modernization Act and signed into law in December 2003. The purpose was to provide a way for Americans to prepare for future medical costs and lower their health insurance premiums by switching to higher-deductible medical plans.
In 2007, individuals can contribute to an HSA up to the lesser of their deductible or $2,850. (Families can contribute $5,650.) If you're over age 55, you can also make a catch-up contribution of $800 in 2007 (with catch-up contributions for the 55-plus set increasing by $100 per year to a maximum of $1,000 in 2009). If an individual contributes to an HSA, he or she can take an "above-the-line" deduction on his or her tax return (dollar for dollar).
If an employer makes a contribution to an employee's HSA, that contribution is not taxable to the employee. If you change jobs, HSAs are portable--so they can go with you.
Self-employed individuals and employers cannot only deduct their contributions to HSAs, they can also deduct the premiums.
Individuals who are not covered by an employer health insurance plan can set up an account and make tax-deductible contributions (although their premiums are not tax deductible).
You can tap the funds in your HSA to pay medical expenses. Withdrawals are tax-free if used for qualified medical expenses.
If you don't need to tap the funds in your HSA, you can let your contributions grow over time tax-free (similar to IRA accounts). HSA contributions grow on a tax-deferred basis.
Unlike flexible spending accounts you may have used in the past, HSA contributions are not "use it or lose it."
To be eligible, you have to meet four requirements:
You have to be covered by a high-deductible health insurance plan. "High-deductible" is defined as a deductible (where you pay the first dollars for medical service out of your own pocket) of $1,100 or higher for singles, $2,200 or higher for families. The out-of-pocket maximum for singles can't be more than $5,500 ($11,000 for families). The high-deductible plans may have no deductible for preventive care and higher out-of-pocket expenses for non-network services.
You can't be covered by another health insurance plan, such as a spouse's plan.
You can't be age 65 and older.You can't be claimed as a dependent on someone else's tax return.
New Developments Affecting HSAs
There are a couple new developments that affect HSAs. On Dec. 20, 2006, the Health Opportunity Patient Empowerment Act of 2006 was passed. Here are some of the HSA-related provisions per The Department of the Treasury:Employers can transfer funds from Flexible Spending Accounts or Health Reimbursement Arrangements to an HSA for employees switching to an HSA compatible plan.You can make a one-time transfer (once in a lifetime) from an IRA to an HSA. But the amount can't be more than the annual contribution limit. You don't get a tax deduction for doing this. It is not considered an early withdrawal, so you will not be subject to the 10% penalty.
Traditional medical costs like diagnosis and treatment of disease are covered by an HSA. In addition, many expenses not covered by traditional medical insurance would be covered: eye care, dental care, prescription and some non-prescription drugs, COBRA premiums, acupuncture, Braille books, midwifery, a seeing-eye dog, qualified long-term care services, and more. The same things you can deduct on Schedule A are considered medical expenses for HSAs. For more on exactly what qualifies, see IRS Publication 502: Medical and Dental Expenses.
If you take a distribution for non-medical expenses and you are under age 65 or not disabled, you'll pay a 10% penalty in addition to ordinary income tax.
What Happens Once You Are Age 65 and Older?
Although your contributions must stop when you're enrolled in Medicare, the accumulated dollars can be used tax-free for qualified medical expenses such as Medicare Part A&B premiums, Medicare HMO, and the employee's share of retiree medical insurance premiums. You can't use the money to purchase a Medigap policy. If you use the money for non-medical expenses, you'll pay tax on your withdrawals (but no penalty).
If you die and have money in an HSA, your spouse can use the account just like it was his or her own. If you are not married, the account can pass to a beneficiary, but will no longer be considered an HSA and it will be taxable to the beneficiary. If your estate is the beneficiary, the value of the HSA will be included on your final income tax return.
Where Can You Set Up an HSA?
So far, HSAs are primarily offered by insurance companies or banks. Insurance companies providing HSAs include UniCare, Fortis, Blue Cross Blue Shield, and Golden Rule. You can also try calling some local banks to see if they offer HSAs or check out the insurance locator. Remember, you have to invest in whatever the institution offers--so choices may be limited.
More Resources on HSAs The Basics of HSAs Department of the Treasury
Morningstar Premium Members get access to over 3,900 Stock and Fund Analyst Reports, Analyst Picks, and award-winning portfolio tools. Learn More.
Morningstar.com-Sue Stevens, CFA, CFP, CPA