Health Savings Accounts (HSAs) ~ Summary/Overview

 

 Last week's blog post recognized (and celebrated!) the upcoming 10th birthday of Health Savings Accounts (HSAs) in 2014.  Recognizing that some readers don't necessarily understand all the "in's and out's" of HSA's, this week's post offers an in depth overview, and addresses many of the key requirements, limitations, benefits, etc.  Once again, HAPPY BIRTHDAY HSAs!

OVERVIEW

A Health Savings Account (HSA) is a tax-favored savings account used to pay qualified medical expenses (See IRS Publication 502; click - http://www.irs.gov/pub/irs-pdf/p502.pdf ), in conjunction with a QUALIFIED HIGH DEDUCTIBLE HEALTH PLAN.  Some have described them as a "medical IRA".  In the employer/group insurance space, an employer and/or employee may contribute tax preferred funds to the account, which accumulate, earning tax-free interest, to pay for qualified expenses.  Outside of the work place, individuals are also eligible to open and fund an HSA if they are otherwise eligible, and have a qualified health insurance plan. Funds used for non-qualified expenses prior to age 65 are subject to a penalty of 20%, plus income tax (unless the account holder is deceased or disabled).

 

The HSA belongs to the individual on whose behalf it is opened, and is portable to the extent an employee changes jobs, becomes unemployed, etc.   HSA funds used to pay for eligible medical expenses are not taxed!  Employees can make pre-tax or tax deductible HSA contributions, subject to specified maximums (see below). Employer and Employee HSA contributions are exempt from payroll related taxes, including federal and state income tax (except AL, CA, and NJ).  Funds remain in the account holder’s control, and unlike Flexible Spending Accounts (FSAs), they NEVER revert to an employer if unused.

In effect, HSAs enjoy specific tax benefits that NO OTHER savings vehicle offers - a TRIPLE tax benefit.  1.Contributions are pre-tax and/or tax deductible. 2. Interest/Dividends accumulate tax free (in most states). 3. Distributions (qualified) are tax exempt.

In order to establish an HSA and take advantage of the tax savings, a qualified high deductible health insurance plan (QHDHP) must be established (Note: additional health insurance coverage, including Medicare, is NOT allowed).  The qualified high deductible plan, often less expensive, and much easier to understand than traditional health plans, acts as a safety net and covers eligible expenses that are beyond the individuals reach, after the deductible (and if applicable, coinsurance) is met.

ADVANTAGES

·         Favorable tax treatment of HSA contributions [Note: contributions are pre-tax or tax deductible.]

·         Reduced insurance premiums through the accompanying qualified high-deductible plan.

·         Tax-free interest on HSAs accumulates over time.

·         Provides funds to pay for qualified medical expenses (including many expenses not covered by traditional insurance plans) through the HSA account.

·         Funds available to pay for COBRA coverage, and in certain cases, individual insurance in between jobs.

·         Funds can be used to supplement retirement without penalty at age 65. Funds can also be used for items such as Long Term Care insurance, Medicare Part B and D premium, and many more qualified expenses.

·         Generally lower health care out of pocket expenses

HSA CONTRIBUTIONS

·         Contributions are limited to a calendar year maximum, as announced by the IRS each year.

       (For 2013: Individual - $3,250; Family - $6,450.  For 2014: Individual - $3,300; Family - $6,550.)

·         Excess contributions are subject to a 6% excise tax plus ordinary income tax.

·         Contribution limits may increase each year according to federal law.

·         Contributions can be made on a pre-tax (generally via payroll) or tax deductible basis. The deadline for HSA contributions in any given year is April 15th of the year following the year in which the contribution is intended to be made.

·         Account holders age 55 and older are allowed to make “catch up” contributions of $1,000          annually. 

SUMMARY

An HSA is comprised of two parts, the first of which is a qualified high-deductible health insurance plan (QHDHP) that covers eligible pharmaceutical, medical and hospital expenses. The second part of the HSA allows you to make tax-free contributions to an investment or regular bank account, from which you can withdraw money tax-free to pay for qualified expenses. The money accumulates with tax-free interest until age 65, when you can withdraw it penalty free for any purpose, and only be subject to ordinary income taxes. Funds that are withdrawn and used for qualified expenses are penalty and tax free.  HSA plans are personally owned by each participant or employee and thus, go with an individual if they leave one job, whether or not they assume employment elsewhere.  To continue funding the account, the participant must stay enrolled in a Qualified High Deductible Health Plan (QHDHP).

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