Last year I wrote a lengthy post on Flexible Spending Accounts (FSA) because the company I work for was looking for ways to help employees cut costs in light of a large health insurance premium increase that we were slated to see. Flexible spending accounts are a great deal because they allow you to set aside a certain amount of money pre-tax for expected health and medical expenses for the year, and then since the money isn't taxed, it could mean hundreds of dollars saved on your taxes. The only proviso is that since it is a spending account, you have to spend the money that year, or you lose it.
We were expecting a baby this year, and as a result we knew we were going to have several thousand dollars in medical costs. We had read that medical costs for having a baby can run anywhere from $3-4000 after insurance kicks in, to even higher if the baby has health issues or has to go to intensive care.
Since we didn't want to risk losing any of the money, we put $3000 in our FSA, out of a maximum possible amount of $5000, meaning we saved almost $1000 in taxes. In the end we ended up spending closer to $4-5000 after insurance kicked in because our baby had to spend some time in the intensive care unit of the hospital – totaling almost $15,000 in health care costs. Thankfully, insurance covered most of that, another reason to have good health insurance!
Today I want to talk about another type of pre-tax account that you can use to help pay for medical costs, and save on your taxes, Health Savings Accounts or HSAs. Because of increased premium costs again this year, my company is currently looking into the possibility of dropping our traditional health insurance coverage in favor of a HSA in combination with a High Deductible Health Plan (HDHP). Here's a rundown of how they work.
Health Savings Accounts
A Health Savings Account (HSA) is basically a savings and investment account that can be funded with your pre-tax dollars to help pay for current or future eligible medial expenses not covered by your insurance plan. Things covered include deductibles, co-insurance, and in some cases health insurance premiums. Basically it's a great way to save on your taxes because you're paying for medical expenses with pre-tax dollars. It also allows your money to grow with no taxes on earnings, and it can then be spent on eligible medical expenses with no taxes taken out! Since it is used in concert with a high deductible insurance plan, it means your premiums are usually lower for insurance as well.
Who Is Eligible To Open A HSA?
Not everyone is eligible to have a Health Savings Account. There are several requirements
- You must be covered by a High Deductible Health Plan (HDHP).
- You can't be covered under another medical health plan that isn't a HDHP.
- You can't be entitled to Medicare benefits.
- You can't be claimed on another person's tax return.
- You can't be eligible for Tricare or have received benefits from the Veteran's administration in the past three months.
The main requirement that applies to most people is that you must have a High Deductible Health Plan to use a HSA.
What Is A High Deductible Health Plan?
So what is a High Deductible Health Plan (HDHP)? It's basically an insurance plan with a high deductible, and high maximum out of pocket costs. It's basically meant to cover catastrophic health events, and you cover much of the rest. Here's how the Treasury explains it:
You must have an HDHP if you want to open an HSA. Sometimes referred to as a “catastrophic” health insurance plan, an HDHP is an inexpensive health insurance plan that generally doesn’t pay for the first several thousand dollars of health care expenses (i.e., your “deductible”) but will generally cover you after that. Of course, your HSA is available to help you pay for the expenses your plan does not cover.
So in other words your HDHP health insurance plan is generally less expensive than traditional health coverage because of the higher out of pocket costs, allowing you to take the difference in costs, and put that money into your HSA pre-tax.
High Deductible Health Plans have an annual deductible minimum (amount you must pay before insurance kicks in), and a maximum out of pocket that is set by the IRS. For the calendar years of 2010 and 2011, those deductibles and out of pocket maximums are as follows:
|For Calendar Year 2015||Minimum Annual Deductible||Maximum Annual Out Of Pocket|
So in other words, in order to have insurance coverage kick in, an individual must pay at least a minimum of the first $1,200 in costs, or for a family – $2,400. After that there will be co-insurance up to the maximums listed.
How Much Can I Contribute To My HSA?
HSAs are similar to FSAs in that they have limits as to how much you or your employer can contribute in a calendar year. For the 2010 and 2011 tax yar the annual contribution limits are:
- Individual Coverage Contribution Limit: $3,050
- Family Coverage Contribution Limit: $6,150
Individuals who are 55 or older may be eligible to make a catch-up contribution of $1,000 in 2010 and 2011.
Withdrawals From Your Health Savings Account
Withdrawals from your HSA for qualified medical expenses are tax-free, which is part of the reason they are so great!
To actually get the money from your HSA, many accounts will just supply you with a debit card so you can pay expenses directly. Others will require to you write yourself a check or even file paperwork to get reimbursed.
Withdrawals for things that aren't approved medical expenses will be taxed as regular income, and as of January 1st 2011, there will be a 20% penalty as well, unless you are over 65 or disabled. (10% penalty until then)
What Expenses Are Eligible To Be Paid With HSA Funds?
Some confusion comes in sometimes when trying to figure out what types of expenses are eligible to be paid via funds in your Health Savings Account. The IRS states it this way:
Medical care expenses are further defined as amounts paid for the diagnosis, cure, or treatment of a disease and for treatments affecting any part or function of the body. The expenses must be primarily to alleviate a physical or mental defect or illness.
Things that might be covered include anything from lab fees to surgery and tons of things in between. For a further look at what constitutes an eligible expense, check out the more detailed IRS Publication 502.
Pros & Cons Of Health Savings Accounts
There are several pros and cons associated with HSAs. Here are a few:
- Pro – Tax Benefits: Your deductions are pre-tax, which reduces your taxable income. The amount can be invested and grow much like a 401k, and there is no tax on earnings. The contributions and earnings can be spent on medical expenses with no tax on your HSA at any point.
- Pro – Plan Ahead For Future Medical Expenses: You may anticipate needing more medical care in the future, like in retirement. Even if you're no longer covered by a HDHP by then, you can still use your HSA funds for medical expenses, and the money will have grown by then.
- Pro – Money Can Be Used In Retirement Without Penalty: If you're healthy in retirement, after age 65 you can withdraw the money for other uses as well, without penalty. You just pay your regular tax rate!
- Pro – The Money Is Yours: Instead of paying higher rates for lower deductibles and out of pocket maximums with an insurance company, you get lower premiums with a HDHP, and you get to keep the money in your HSA. It's yours! You aren't just passing all your money to the insurance company! And you can invest the money much like in a 401k or IRA.
- Pro – The Money Rolls Over Every Year: Unlike a FSA (a Flexible Spending Account), the HSA is a savings account, so any funds not used on medical care roll over to the next year, and continue to grow.
- Con – More Risk: At the outset when you don't have as much money in your HSA, you run the risk of having an event, and not having enough money in your account to cover deductibles and co-insurance up to the maximum. For that reason until your account is fully funded, you're at risk. Of course if you have an emergency fund, you'll be covered.
- Con – If You're Unhealthy, You Could Pay More: For healthy people a HSA is quite often the best deal – as they pay less in premiums and often don't use much medical care. For others who have major medical issues, a HSA and High Deductible Health Plan may mean they end up paying more for health care. It's something that needs to be researched before you jump in.
The key to knowing whether or not the HSA is right for you is to research your own situation, and see if the numbers add up. Check out your possible coverage under a traditional plan, figure out how much medical care you use, and see whether or not it will end coming out ahead under a Health Savings Account. Chances are it will be the appropriate plan for your family as well.
What do you think of Health Savings Accounts? Do you have one, and does it help you to save on medical costs? What are you favorite features of the HSA? Tell us your thoughts in the comments.
Other HSA Resources:
- Health Savings Accounts and Other Tax Favored Health Plans: IRS .pdf on the topic.
- HSA – Wikipedia explanation of Health Savings Accounts
- HSA frequently asked questions: From the US Treasury.