Manage Healthcare Costs with a Health Savings Account

The ABCs of HSAs and HDHPs!

A health savings account may save you money at tax time. 1Stockphoto

What Is a Health Savings Account?

A health savings account (HSA) is a type of account that you can put money into to save for health-related expenses on a tax-free basis.

You can contribute to a health savings account only if you:

  • have a high deductible health plan (HDHP)
  • have no other medical insurance coverage, including Medicare – however, you are permitted to have other types of health-related coverage, such as accident, disability, dental care, vision care, or long-term care insurance.
  • cannot be claimed as a dependent on someone else’s tax return

Both you and your employer can make contributions to your HSA. However, the total amount of the contributions cannot be more than an annual limit set by the government. In 2018, the maximum contribution is $3,450 if you have self-only coverage under an HDHP, and $6,900 if you have family coverage (two or more people covered) under an HDHP (note that the family HSA contribution limit was initially $6,900 for 2018, and was lowered to $6,850 under the terms of an IRS Bulletin that was published in March 2018. But that bulletin was reversed by Revenue Procedure 2018-27, which put the family HSA contribution limit back to $6,900 for 2018).

Any contributions made to your HSA must be cash; contributions of stock or property are not allowed. Also, you cannot make any contributions to your HSA when you enroll in Medicare. However, you can keep the money in your HSA and use it to pay for medical expenses tax-free.

If you withdraw money from your HSA without incurring qualified medical expenses, you'll pay income tax on the money, as well as a penalty. The penalty on distributions from your HSA that are not used for qualified medical expenses increased from 10 percent to 20 percent in 2011, as a result of the Affordable Care Act.

Tax Benefits
According to the Internal Revenue Service (IRS), HSAs have the following tax-related advantages:

  • You can claim a tax deduction for contributions you or someone other than your employer, make to your HSA.
  • Contributions to your HSA made by your employer may be excluded from your gross income.
  • Any interest or other earnings you make on the money in your HSA are tax-free.
  • Money that you take out of your HSA may be tax-free if you use it to pay “qualified” medical expenses.
  • There is no deadline for reimbursing yourself for medical expenses using your HSA. As long as the qualified medical expense was incurred after you established the HSA, you can wait years or decades to take the money out of the HSA to cover the medical expense (keep your receipts, as you'll need them if the IRS asks you to prove that you did, in fact, incur the medical expenses for which you're reimbursing yourself). 
  • After age 65, you can take money out of an HSA for any purpose you want, without a penalty. But if you're not using the money for qualified medical expenses, you'll pay income tax on the withdrawal, just as you would from a traditional IRA.

    You can find details about the tax benefits and rules (including examples of how HSAs work) in IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.

    Signing Up for an HSA
    Banks, credit unions, insurance companies and other financial institutions are permitted offer and oversee HSA accounts. Your employer may also have set up a plan that will help you sign up. Note that your HSA is not something you purchase; it’s a savings account into which you can deposit money on a tax-preferred basis.

    What Is a High-Deductible Health Plan?

    If you decide to open an HSA, you must have a high-deductible health plan (HDHP). An HDHP is a type of health insurance plan that has to conform to very specific IRS rules. There are regulations regarding minimum deductibles and maximum out-of-pocket limits, and the plan cannot provide any benefits other than preventive care (as defined by the IRS) before the deductible.

    In 2018, an HDHP has to have a deductible of at least $1,300 for a single person, or $2,600 for a family. And the plan cannot have a maximum out-of-pocket in excess of $6,550 for a single person, or $13,100 for a family. The amount of the required minimum deductible and out-of-pocket expenses is adjusted annually to account for inflation.

    The upper limits on out-of-pocket costs for HDHPs are lower than the general maximum out-of-pocket limits that apply to other plans. In 2014, they were the same, but the formula used to increase the out-of-pocket limits for HDHPs differs from the formula used to increase the out-of-pocket limits for other plans, so the upper limits have diverged with time.

    Because non-HDHPs can have higher out-of-pocket limits, HDHPs aren't necessarily the plans with the lowest premiums, which will be apparent if you're shopping for your own coverage in the individual market. But if your options are limited by an employer and one of the available plans is an HDHP, it will likely be the lowest-priced plan your employer is offering, as the other available plans are likely to include benefits (like copays for office visits, instead of you having to pay the full cost of the office visit) before the deductible.

    You can use your health savings account to help pay for the expenses your health plan does not cover.

    A Dr. Mike Definition: Deductible - A deductible is the amount you must pay out-of-pocket each year for health-related expenses before your insurance policy begins to pay. Under an HDHP (which you must have in order to contribute to an HSA), your deductible in 2018 will be at least $1,350 for single coverage, and at least $2,700 for family coverage.

    Enrolling in a High-Deductible Health Plan
    Any company that sells health insurance in your state may offer an HDHP. Your employer may offer an HDHP and you also should be able to find a qualified HDHP by contacting the exchange in your state, your current insurance company, or an agent or broker licensed to sell health insurance in your state. Your state insurance department may also be able to provide information about qualified HDHPs.

    What are Qualified Medical Expenses?

    IRS Publication 502 defines qualified medical expenses as "the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body. These expenses include payments for medical services rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes."

    Under the terms of the Affordable Care Act, you can no longer be reimbursed on a tax-free basis for the costs of over-the-counter medications, unless your doctor provides you with a prescription for them

    What Are the Pros and Cons of Health Savings Accounts?

    The U.S. Treasury Department explains that the advantages of HSAs and HDHPs include:

    • They provide security by protecting you against high or unexpected medical bills.
    • Coverage may be more affordable due to lower health insurance premiums, since the plans do not.provide benefits beyond preventive care until you've met your deductible.
    • You have the flexibility to use the funds in your account to pay for medical expenses, including expenses that your insurance may not cover.
    • You can save the money in your account for future medical expenses.
    • You can grow your account through investment earnings.
    • You make all the decisions about how much money to put into your account, whether to save the money for future expenses or pay current medical expenses, and which medical expenses to pay with HSA funds. You can choose to pay for medical expenses with non-HSA funds (ie, with after-tax money), save your receipts, and then reimburse yourself years or decades later, with tax-free money from the HSA. In this way, an HSA can be used as an emergency fund or early retirement account.
    • You can keep your HSA even if you change jobs, change your medical coverage, become unemployed, move to another state, or change your marital status. You can only make contributions to your HSA during time that you have HDHP coverage in place. But the money in the HSA is yours and can be used to cover qualified medical expenses at any time in the future, regardless of what type of health insurance coverage you have (or don't have) at that point.
    • Your funds remain in the account from year to year – there are no “use it or lose it” rules

    Additionally, your HSA provides you triple tax savings:

    1. tax deductions when you contribute to your account
    2. tax-free earnings through investment
    3. tax-free withdrawals for qualified medical expenses

    A number of consumer organizations, including Consumers Union, the publisher of Consumer Reports, have been critical of HSAs because they provide the greatest benefit to young healthy people who do not have dependents and wealthy people who can save more on their taxes.