Slowly but surely, the public is starting to become aware of health savings accounts (HSAs) and the impact they can have for uninsured people who qualify for them. This relatively new type of medical savings account allows for tax-deductible contributions and tax-free distributions as long as the money is used to pay for qualified medical expenses.

Any unused funds in these accounts eventually can be withdrawn as retirement income. Therefore, they not only can provide a means to pay for medical insurance and expenses, but also can function as an additional avenue for retirement savings. (To learn more about saving for retirement, see our Retirement Planning Basics tutorial.) In this article we'll show you what you need to qualify for these accounts and if they are right for you.

Qualifications for HSA Eligibility

The basic requirements that must be met to open one of these accounts are as follows:

  1. Neither the account holder nor his or her spouse can have access to any other type of standard group health insurance coverage (but coverage for dependents is allowed). Whether the account holder or spouse actually participates in the other plan is irrelevant; eligibility for the plan alone will disqualify them from health savings account participation. Medicare coverage for either spouse will also disallow contributions for that spouse, although such things as prescription discount cards are permitted. In some cases, veterans are also excluded from opening health savings accounts. (Read more about Medicare in Fighting The High Costs Of Healthcare,Medicare: Defining the Lines and Getting Through The Medicare Part D Maze.)

  2. The account holder must also purchase a qualifying high-deductible health insurance policy (HDHPs) that has a minimum deductible of $1,100 for singles or $2,200 for families. High-deductible health policies are structured specifically to pay only for major or catastrophic medical expenses. The annual out-of-pocket copays cannot exceed $5,500 for singles or $11,000 for families. These policies are allowed to have first-dollar coverage for preventive care and higher limits for non-networked expenses. Catch-up contributions are also available for those aged 55 and up. The catch-up contribution limit is $800 for 2007, $900 for 2008 and $1,000 for 2009 and beyond. (To find out more, see Retirement Savings Tips For 45- To 54-Year-Olds.)

  3. For 2007, the contribution limits for health savings accounts are $2,850 for singles and $5,650 for families. These limits will increase to $2,900 for singles and $5,800 for families in 2008. The contribution amount is allowed to exceed the deductible from the policy. (It should be noted here that the health savings account itself is separate from the actual high-deductible health insurance policy that must be purchased to qualify for it.) While a contributor can make the contribution at any time during the year in any amount desired within the prescribed limits, the financial institution administering the account may impose a minimum required deposit or current balance.
  4. Many different financial institutions such as banks, credit unions, brokerage firms and insurance companies offer these plans, and the number is rapidly growing.

Tax Benefits of HSAs
Once the requirements have been met, however, health savings accounts provide the following tax advantages:

  1. All contributions made to these accounts are classified as above-the-line deductions on the taxpayer's 1040, just like IRA or other retirement plan contributions. Itemization of deductions is therefore unnecessary.
  2. Because long-term care insurance is considered a qualified expense under these plans, all premiums paid for a tax-qualified policy become deductible within certain limits, as long as the account holder is age 65 or above. Regular health and medical insurance premiums can also be deductible for those under 65 who are unemployed. (Keep reading on this subject in Long-Term Care Insurance: Who Needs It?)

  3. All distributions from health savings accounts that are used to pay for qualified medical expenses are tax free. For the purpose of health savings accounts, "qualified medical expenses" has an extremely broad definition, encompassing everything from over-the-counter drugs to acupuncture and other esoteric remedies, as long as they are not for cosmetic treatment. Furthermore, the money contributed to the accounts can be invested (the types of investments permitted are the same as for IRAs). This means that over time, it is possible to achieve tax-free income generated solely by the investment portfolio within the account.
  4. A one-time transfer of an IRA or Archer MSA balance to a health savings account is also permitted, up to the contribution limits. This is obviously an advantage for those who have medical bills that an IRA distribution must be taken to pay for. (For related reading, see Tax Treatment Of Roth IRA Distributions.)
  5. Perhaps best of all, any unused money that is not paid out for medical expenses can eventually be used as retirement income, just like an IRA. This substantially reduces much of the risk inherent in paying for traditional health insurance, where the premiums paid are lost if no claim is made.

Additional Benefits of HSAs
For those that qualify, HSAs can resolve a huge dilemma between saving for retirement and paying current or future medical bills. This is particularly true when long-term care may be needed. While the cost of a nursing home or other skilled care can be staggering for many, the opportunity cost of paying for long-term care insurance is also very high. Health savings accounts can valuable in these cases, as shown in the following example:

Joe and Betty Smith own a successful jewelry business. Joe and Betty are 65. Neither of them has access to group health insurance of any kind. Joe has had a respiratory problem for years, and Betty\'s family has a history of heart disease. They are currently contributing to a self-employed 401(k), but they are concerned about the possible medical or long-term care bills that they may have to pay in the future. They are not sure if they have sufficient assets or income to fund both their retirement and their possible health costs.
The solution, of course, is to open a health savings account. They can contribute $5,650 to the account each year, plus an additional catch-up contribution for Joe. The premiums that they pay for their HDHPs are deductible as well. Furthermore, if they decide to pay for long-term care insurance, most or all of the premiums can be paid for with distributions from the account. Because contributions are deductible and distributions are tax-free, the Smiths are able to deduct the most or all of the cost of their long-term care insurance policy, which otherwise would not have been possible.
Finally, all money contributed will grow tax free until used for medical bills, or tax deferred until used as retirement income. One way or another, the Smiths are certain to be able to use the money (barring what is paid for the HDHP premiums) constructively for something! This will simplify and improve the Smiths\' ability to plan for their retirement. They could decide to roll over a portion of their 401(k) up to the contribution limit into the account if they feel certain that they will have to use the plan\'s assets to pay medical bills. This transfer will, of course, reduce their tax bill accordingly.

Health savings accounts ultimately represent the next major step forward in tax relief for those without access to group health coverage. Those who qualify have absolutely nothing to lose by opening one, as all contributions are guaranteed to be used one way or another.

Related Articles
  1. Investing

    Five Things to Consider Now for Your 401(k)

    If you can’t stand still, when it comes to checking your 401 (k) balance, focus on these 5 steps to help channel your worries in a more productive manner.
  2. Investing Basics

    Explaining Rehypothecation

    Rehypothecation occurs when an asset used as collateral for one party is reused in another transaction.
  3. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Insurance

    Learn about the SPDR S&P Insurance exchange-traded fund, which follows the S&P Insurance Select Industry Index by investing in equities of U.S. insurers.
  4. Retirement

    The World's Most Luxurious Retirement Destinations

    If money is no object (or if you would just like to dream), these five spots are the crème de la crème.
  5. Retirement

    Strategies for a Worry-Free Retirement

    Worried about retirement? Here are several strategies to greatly reduce the chance your nest egg will end up depleted.
  6. Professionals

    Your 401(k): How to Handle Market Volatility

    An in-depth look at how manage to 401(k) assets during times of market volatility.
  7. Professionals

    How to Build a Financial Plan for Gen X, Y Clients

    Retirement is creeping closer for clients in their 30s and 40s. It's a great segment for financial advisors to tap to build long-term client relationships.
  8. Retirement

    Maxing Out Your 401(k) Is Profitable: Here's Why

    It's shocking, but most American workers (73%) have no 401(k) retirement funds. Start saving now to anchor your retirement.
  9. Technical Indicators

    Key Financial Ratios to Analyze Retail Banks

    Learn about key financial metrics that investors use to evaluate retail banks, and how the industry is fundamentally different from most other industries.
  10. Retirement

    How to Choose the Best Long-Term Care Insurance

    Here's how to find and select a policy that provides the best coverage for you.
  1. Section 1231 Property

    A tax term relating to depreciable business property that has ...
  2. Emergency Banking Act Of 1933

    A bill passed during the administration of former U.S. President ...
  3. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced ...
  4. Qualified Longevity Annuity Contract

    A Qualified Longevity Annuity Contract (QLAC) is a deferred annuity ...
  5. The New Deal

    A series of domestic programs designed to help the United States ...
  6. Net Collections

    A term used in medical accounting to describe the amount of money ...
  1. Why are IRA, Roth IRAs and 401(k) contributions limited?

    Contributions to IRA, Roth IRA, 401(k) and other retirement savings plans are limited by the IRS to prevent the very wealthy ... Read Full Answer >>
  2. Where are the Social Security administration headquarters?

    The U.S. Social Security Administration, or SSA, is headquartered in Woodlawn, Maryland, a suburb just outside of Baltimore. ... Read Full Answer >>
  3. What is the Social Security administration responsible for?

    The main responsibility of the U.S. Social Security Administration, or SSA, is overseeing the country's Social Security program. ... Read Full Answer >>
  4. What are the best ways to use your 401(k) without a penalty?

    The best way to use your 401(k) retirement savings account is to take normal distributions after you reach retirement age. ... Read Full Answer >>
  5. Is the Social Security administration a government corporation?

    The U.S. Social Security Administration (SSA) is a government agency, not a government corporation. President Franklin Roosevelt ... Read Full Answer >>
  6. Can I take my 401(k) in a lump sum?

    Establishing a retirement savings plan during your working years is a necessary part of comprehensive financial planning. ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!