Since Health Savings Accounts (HSAs) were established in 2003 as part of the Medicare Prescription Drug, Improvement and Modernization Act, they have become an increasingly popular option for consumers and employers seeking to manage their healthcare costs. HSAs combine high-deductible health insurance plans with tax-favored savings accounts. With a High-Deductible Health Plan (HDHP), you generally pay less each month in premiums, and the money in the savings account is then used to help pay healthcare costs before the deductible is met. Contributions to the HSA are tax deductible, and withdrawals are tax-free when used to pay for qualified medical expenses, including dental and vision – expenditures many traditional health insurance plans may not cover. Here, we answer questions you might have about Health Savings Accounts and how they work.
Who can open a Health Savings Account?
According to federal guidelines, you can open and contribute to an HSA if you:
- Are covered under a High-Deductible Health Plan on the first day of the month (see next question)
- Are not covered by any other non-HDHP plan (with some exceptions for certain plans with limited coverage, such as dental, vision and disability)
- Are not enrolled in Medicare
- Are not claimed as a dependent on someone else's tax return
What is a High Deductible Health Plan?
As the name implies, High Deductible Health Plans (HDHPs) are health insurance plans with high deductibles. The IRS establishes guidelines each year that are adjusted for inflation. For 2014, all HDHPs must have a minimum deductible of $1,250 for individuals and $2,500 for families, and the out-of-pocket maximum (including deductibles, co-payments and co-insurance, but not premiums) cannot exceed $6,350 for individuals and $12,700 for families.
How much money can I contribute each year?
The IRS sets limits that determine the combined amount that you, your employer and any other person can contribute to your HSA each year. For 2014, the maximum contribution amounts are $3,300 for individuals and $6,550 for family coverage. You can add up to $1,000 more as a "catch-up" contribution if you are age 55 or older at the end of your tax year. Contributions are reported on IRS Form 8889 and Form 1040.
How can I use the money?
The funds in your HSA can be used to pay for qualified medical expenses incurred by you, your spouse and your dependents. The IRS establishes what is and what is not a qualified medical expense, detailed in IRS Publication 502, Medical and Dental Expenses. Generally speaking, qualified expenses include amounts paid for the diagnosis, cure, mitigation, treatment or prevention of disease, and treatments for conditions that affect any part or function of the body. Expenses for cosmetic reasons and expenses that benefit your general health (for example, vacations) are excluded.
Is preventive care covered by a HDHP?
Yes. Under current healthcare law, most plans must cover certain preventive care without a deductible or co-payment. So even though your plan has a high deductible, preventive care, such as annual physicals, well-child visits and routine vaccinations are covered at no charge to you. Ask your health insurance provider for a current list of preventive services.
What happens if I use my HSA funds for a non-qualified health expense?
If you withdraw funds for a non-qualified expense before you turn 65, you'll owe taxes on the money (it will be taxed as income) plus a 20% penalty. If you are over 65 – or become disabled at any age – you'll owe taxes on the amount but not the penalty.
What if I don’t use all the money by the end of the year?
Any money that is in your account at the end of the year remains in your account to pay for future qualified medical expenses. The account belongs to you; even if you change health insurance plans, change jobs or retire, the funds stay in your account and are yours to use.
How can I set up an HSA?
You'll need a HDHP before you can set up a Health Savings Account. Once that's in place, you can contact your employer's human resources department if your employer offers HSAs. If it doesn't, contact your health insurance company for details on setting up an HSA through its recommended bank, or select a financial institution on your own. Your local bank or credit union may offer HSAs and can provide you with enrollment information. You can also look online (try an Internet search for "HSA providers"). Once you select a bank, the enrollment process is fairly straightforward and involves completing an application and funding the account. After that, you can begin using the funds for qualified medical expenses.
The Bottom Line
HSAs are worth investigating as a way of saving money on healthcare. If you're considering one and currently have traditional health insurance, look at whether you would have saved money last year if you'd had an HSA instead of the plan you have now. If your plan doesn't cover dental or vision care – and you have significant expenses in these areas – an HSA could be especially helpful. On the other hand, if you incur substantial health costs for standard medical care, the High-Deductible Health Plan required to open an HSA might not be the right choice for you. For more information, read Comparing Health Savings and Flexible Spending Accounts.