Created in 2003 as part of the Medicare Prescription Drug and Modernization Act of 2003, health savings accounts (HSAs) have gained in popularity over the past decade. According to the Employee Benefit Research Institute (EBRI), more employers and employees have been contributing to HSAs in recent years, and the amount contributed to HSAs has generally been on the rise. For example, the percentage of individuals in employee-only HSAs contributing $1,500 or more rose from 21% in 2006 to 42% in 2012, while the percentage of employees contributing nothing decreased from 28% to 15% over that same period. (Sources: "HRA/HSA Health Plan Contributions Continue to Grow," EBRI, February 20, 2013, and EBRI Notes, February 2013.) If you are eligible to contribute to an HSA, you may want to take another look at these savings plans, which could benefit your financial situation both now and in the future.
Health savings accounts help individuals and families set aside money on a tax-advantaged basis to pay for health-care costs. HSAs are typically offered by employers along with what's known as "high-deductible health plans," or HDHPs--health insurance plans that generally offer lower premium payments in exchange for high annual deductibles (at least $3,350 for individuals and $6,750 for families in 2016).* You must be enrolled in an HDHP in order to participate in an HSA. If your employer provides an HDHP but does not offer an HSA, you may be able to establish an account on your own through a financial institution. Self-employed individuals can also use HSAs.
Here's how an HSA works:
You can contribute up to $3,2350 for individual coverage or $6,750 for family coverage to an HSA in 2016. If you are age 55 or older, you may also make "catch-up" contributions of up to $1,000.
Your employer may also make contributions on your behalf.
You can contribute in one lump sum or in periodic (e.g., monthly) amounts.
You can make contributions for the current year up until your tax-filing deadline (generally, April 15 of the year following the year of coverage).
One of the key advantages of an HSA is that your contributions are tax deductible. If your plan is offered through your employer, you may be able to make automatic contributions on a pretax basis (similar to a work-based retirement savings plan) and any employer contributions are generally excluded from your gross taxable income as well. Moreover, you can typically select from a variety of savings and investment vehicles for your contribution dollars, and the earnings grow tax deferred until you withdraw them. Withdrawals then used for qualified medical expenses are tax free.
You can withdraw money from your HSA to pay for qualified expenses for yourself, your spouse, or your dependents. Permitted expenses include:
- Health insurance deductibles and co-payments
- Prescription drugs
- Vision care and eyeglasses
- Dental care
- Laboratory fees
- Hearing aids and more
For a complete list of eligible expenses, please see IRS Publication 502.
On the other hand, HSA distributions that you use for nonqualified expenses are subject to income taxes and a 20% penalty tax.
In order to be eligible for an HSA, you must have qualifying HDHP coverage. You won't be eligible if you're covered by another health plan (e.g., your spouse's nonqualified health plan), if you're 65 and enrolled in Medicare, or if someone else can claim you as a dependent. In addition, you may be ineligible if you're covered under a flexible spending account or health reimbursement arrangement that offers coverage similar to the HSA's.
Plans that won't affect your eligibility include dental and vision care insurance, long-term care insurance, and disability and accident insurance.
Unlike flexible spending accounts, where you have to use up all the funds you set aside for a plan year by a certain date or forfeit the money, HSA funds are yours to keep. If you leave your current employer and would like to roll your HSA money into another HSA, you are typically permitted to do so. And provided you are still eligible, you can continue to save in your account on a tax-deferred basis until you enroll in Medicare.
*Total out-of-pocket costs for HDHPs cannot exceed $6,250 for individuals and $12,500 for families.