Not sure if your health insurance qualifies you for a health savings account or HSA? Laura answers a listener question and covers the facts about what an HSA is and the rules to qualify for one.
A health savings account or HSA is a type of tax-advantaged account that was created in 2003 to help Americans manage and reduce medical expenses. With rising healthcare costs, there’s a lot to love about HSAs—but also a lot to know.
I received a question from Money Girl listener Lydia G., who says, “My family owns a small business and we administer our health plan. It’s a PPO with copays and deductibles of $3,500 in network and a maximum out of pocket expense of $7,350. I would love to set up an HSA for myself and my spouse, who is also covered under our plan. How can I make sure that our health plan qualifies for an HSA?”
In this post I’ll answer Lydia’s important question and cover the facts about what an HSA is and the rules to qualify for one. If your health plan qualifies for an HSA, it’s one of my favorite ways to cut medical costs and save more money.
What Is an HSA?
First, let’s review what an HSA is and how it helps you save money. As I mentioned, it comes with tax advantages, specifically three benefits:
1. Your HSA contributions are never taxed.
An HSA is funded with pre-tax dollars, whether you make contributions or your employer does so on your behalf. If you fund the account on your own, you claim total annual contributions as a deduction on your taxes (even if you don’t itemize deductions). If an employer makes your contributions, they’re deducted from your paycheck before taxes are taken out.
You can make tax-deductible contributions to an HSA at any time during the year, even up to April 15 for the previous tax year. You can contribute even if you’re retired, unemployed, or have annual income less than your contributions. And you’re never required to make HSA contributions.
2. Your HSA earnings are never taxed.
Most HSAs pay interest on your balance, just like a bank savings account. Plus, you typically also have the option to transfer all or a portion of your HSA to investments, such as mutual funds, to grow your balance.
Unlike with a taxable bank or brokerage account, interest or investment growth in an HSA is completely tax free.
3. Your HSA withdrawals are never taxed.
When you take money out of an HSA, there are no taxes. This is true no matter if you withdraw original contributions, interest income, or investment earnings from the account to pay for qualified healthcare expenses.
The bottom line is that you don’t have to pay federal income tax, Social Security and Medicare tax, or state income taxes (in most states) on funds deposited into or withdrawn from the account. Your funds can be spent on a variety of medical expenses that aren’t covered by your health insurance, such as your deductible, dental bills, vision expenses, prescription drugs, and copays.
How Much Can You Contribute to an HSA?
There’s no requirement for HSA participants to make contributions, but there are annual caps. For 2018, you can contribute up to $3,450 if you have insurance for just yourself, or up to $6,900 if you have a family plan. If you’re over age 55, you can also contribute an additional $1,000.
In many cases, employers also contribute HSA matching dollars when you enroll in a HDHP at work. If so, contributions from your company must be included in the annual limit. No matter if you get an HDHP on your own or through an employer, you're still eligible for an HSA.
Funds you don’t spend simply roll over from year to year, making an HSA a convenient and easy way to save for future medical expenses. You own your HSA at all times and can take it with you when you change medical plans, change jobs, or retire.
While these benefits are amazing, not everyone can cash in. You can only have an HSA when you also have a type of insurance known as a high deductible health plan, which I’ll cover in a moment.
Additionally, you generally can’t have any other health coverage besides an HDHP, or be enrolled in Medicare. Also, you can’t be claimed as a dependent on someone else’s tax return.
The downside of an HSA is that spending any amount of it on non-qualified expenses, like groceries or a vacation, subjects you to income tax plus a 20% penalty on those amounts. So never put money into an HSA that you might need for everyday expenses.
Check out the long list of qualified medical costs you can pay for using an HSA in IRS Publication 502, Medical and Dental Expenses.