What is a Health Savings Account – HSA?
A Health Savings Account (HSA) is a tax-advantaged account created for individuals who are covered under high-deductible health plans (HDHPs) to save for medical expenses that HDHPs do not cover. Contributions are made into the account by the individual or the individual's employer and are limited to a maximum amount each year. The contributions are invested over time and can be used to pay for qualified medical expenses, which include most medical care such as dental, vision, and over-the-counter drugs.
How a Health Savings Account – HSA – Works
A Health Savings Account is one of the ways an individual can cut costs if they are faced with high deductibles. A deductible is the portion of an insurance claim that the insured pays out-of-pocket. A high-deductible health insurance plan (HDHP) is an insurance plan that has a higher annual deductible than typical health plans, with a minimum and maximum deductible of $1,350 and $6,750 (as of 2019), respectively, for individuals. For families, the minimum is $2,700 and the maximum is $13,500.
When an individual has paid the portion of a claim they are responsible for, the insurance company will cover the remaining portion, as specified in the contract. For example, under the HDHP, an individual with a deductible of $1,500 who makes a medical claim for $3,500 will have to pay $1,500 since the insurer is only responsible for the excess, which is $2,000. To supplement the funds that an insured has to pay out-of-pocket, a Health Savings Account (HSA) can be used.
Qualifying for a Health Savings Account – HSA
An individual who has an HDHP may qualify for a Health Savings Account. The HSA is usually paired with qualified HDHP and offered by a health insurance provider. An HSA can also be opened at a number of financial institutions. To qualify for an HSA, the taxpayer must be eligible, as per standards set out by the Internal Revenue Service (IRS). An eligible individual is one who has a qualified HDHP, has no other health coverage, is not enrolled in Medicare and is not a dependent on someone else’s tax return.
Any eligible individual can contribute to an HSA in cash only. An HSA owned by an employee can be funded by the employee and/or his employer. Any other person, such as a family member, can also contribute to the HSA of an eligible individual. Individuals who are self-employed or unemployed may also contribute to an HSA, provided they meet the qualifications of owning a Health Savings Account in the first place.
For 2019, the contribution limit to an HSA is $3,500 for self-coverage, up by $50 from 2018. Individuals with families can contribute up to $7,000 (up from $6,900 in 2018). Individuals who are 55 years or older by the end of the tax year can contribute an additional $1,000 to their HSAs. Contributions made by an employer to an HSA are included in the limit. For example, an individual who opts for the maximum contribution limit of $3,500 can contribute only $2,000 if his employer contributes $1,500.
The 2019 HSA contribution limits are $3,500 for a self-only account and $7,000 for a family account, up by $50 and $100 from 2018, respectively.
Tax Advantages of a Health Savings Account – HSA
There are a number of advantages (as well as drawbacks) inherent to HSAs. The HSA is most advantageous to account owners because funds are contributed to the account using pre-tax income. The portion of pretax income that is used to fund an HSA, lowers a taxpayer’s total taxable income, translating into a lower tax liability for the individual.
In addition, contributions made to an HSA are 100% tax deductible and any interest earned in the account is tax-free. However, excess contributions made to an HSA incur a 6% tax and are not tax deductible. Aside from a few administrative changes, the Tax Cuts and Jobs Act of 2017 did not directly affect HSAs.
Withdrawals Permitted Under a Health Savings Account – HSA
As long as withdrawals from a Health Savings Account are used to pay for qualified medical expenses that are not covered under the HDHP, the amount withdrawn will not be taxed.
- Qualified medical expenses include deductibles, dental services, vision care, prescription drugs, co-pays, psychiatric treatments and other qualified medical expenses not covered by a health insurance plan.
- Insurance premiums usually don’t count towards qualified medical expenses unless the premiums are for Medicare or other healthcare coverage if 65 years or more, for healthcare insurance while unemployed and receiving unemployment compensation and for long-term care insurance.
If any distributions made from an HSA for reasons other than paying for medical expenses, the amount withdrawn will be subject to both income tax and an additional 20% tax penalty. Individuals who are 65 years old or older will no longer be able to contribute to an HSA, but can withdraw any funds accumulated in the account for any expense without incurring the 20% penalty. However, income tax will still apply to any non-medical usage.
Health Savings Account – HSA – Contribution Rules
Contributions made to an HSA do not have to be used or withdrawn during the tax year. Any unused contributions can be rolled over to the following year. Also, an HSA is portable, meaning that if an employee changes jobs, they can still keep their HSA. In addition, an HSA plan can be transferred to a surviving spouse tax-free upon the death of the account holder. On the downside, HSAs come with specific withdrawal rules and a recordkeeping burden that may be difficult to keep up with.
Health Savings Account – HSA – vs. Flexible Savings Account
The Health Savings Account is often compared with the Flexible Savings Account (FSA). While both accounts can be used for medical expenses, some key differences exist between them. For example, unused funds in the FSA during a given tax year are forfeited once the year ends. Also, while the elected contribution amount for the year can be changed by an employee with an HSA anytime during the year, the elected contribution amount for an FSA is fixed and can only be changed at the beginning of the following tax year.
Health Savings Accounts should not be confused with Health Spending Accounts, which are used by employers in Canada to provide health and/or dental benefits for their employees residing in Canada.