Saving for Medical Expenses with an HSA
A health savings account or HSA is designed to allow US citizens to save for medical expenses tax free. If you're an individual enrolled in a qualified high-deductible health plan and are not enrolled in Medicare Part A or B, you are eligible to start and contribute to a health savings account. You cannot start an HSA for individuals who can be claimed as a dependent on another person's tax return – which means health savings accounts are basically only available to adults.
Contributions made to a health savings account are tax deductible. Qualifying distributions from an HSA are also tax-free, but like other tax-advantaged savings, taking unqualified distributions is a costly move that results in taxable income and a 10% penalty.
Opening an HSA
Once you've determined you are enrolled in a qualified HSA-compatible high deductible health insurance plan, you can open a health savings account. It is a good idea to call the bank or financial institution you intend to establish your HSA with before going, as many do not open the accounts in branch offices but instead require you to visit their HSA administrators in another office location. You will typically need to provide verification of your high deductible health insurance plan to enroll in a health savings account.
Application forms are generally available on HSA administrator websites, either for printing or filling out electronically. To open the account you need to cover minimum balance requirements and pay any set up fees charged by the administrator to establish the account.
Once established, you will typically receive a welcome package which gives you details for how to use your health savings account, maintenance fees and the standard financial documents for the account, along with a book of checks and a debit card to access your money.
Health Savings Account Contributions
Contribution limits for health savings accounts may change from year to year and vary depending whether you are contributing to a single HSA or a family HSA. The plan requirements may change as well. Currently, the restrictions are as follows:
- Annual contribution limits: Single – $3,050 and Family – $6,150
- Catch-up contributions: $1,000 per individual age 55 or older
- Minimum deductibles: Single – $1,200 and Family – $2,400
- Maximum out-of-pocket expenses: Single – $5,950 and Family – $11,900
While there are no federally legislated minimum contribution requirements, each HSA administrator may set their own minimum initial deposits and minimum balance requirements.
If you open a health savings account mid-year, the contribution limits are not subject to pro-rating. This means you can contribute up to the maximum contribution limits for the tax year, regardless of the date you open the account. In order to claim the HSA contribution tax deduction, you must make your contribution before the current year's tax filing deadline.
Contributions must be made with cash. You cannot make contributions to an HSA with stocks or other investments or property, but you can rollover a contribution from another health savings account or Archer MSA. If you are switching your health insurance plan to a qualified HSA-compatible plan, your employer can transfer money from a Health Reimbursement Arrangement (HRA) or a Flexible Spending Accoun (FSA), as well. Money from a rollover contribution are not subject to the annual HSA contribution limitations. Another option to fund your HSA is to make a one-time contribution from an Individual Retirement Account (IRA). You can only do this once in your lifetime, and the contribution must be handled with a direct trustee-to-trustee transfer.
You can make your contributions at whatever frequency you want – some people choose to make regular monthly deposits while others prefer to make an annual lump sum contribution. You can choose how to make HSA deposits and it does not have to coincide with when you pay your health insurance premiums as many people mistakenly believe.
Employer HSA Contributions
When employers contribute to their employees' health savings accounts, they are required to follow discrimination guidelines. These guidelines are set up to ensure equal contributions are made to lower paid employees as higher paid. If contributing to one employee's account, they must make comparable contributions into all comparable and participating employees. By comparable, the contributions must be the same percentage of employee's health plan deductible, or the same dollar amount for each employee.
Contributions made to a health savings account by employers do not generate taxable income for employees as long as the employer follows discrimination guidelines. The employer contributions to employee HSAs are tax-deductible health and welfare expenses.
Tax Implications of Excess HSA Contributions
If you contribute more than the maximum limit, contributions above the limit are not tax-deductible. If an employer's contribution causes you to exceed annual limits, the amount in excess is taxable income to you, and you will also pay a 6% excise tax. You can avoid paying tax on excess contributions and the 6% excise tax penalty by taking a distribution from your health savings account prior to the federal income tax deadline of the year the contributions exceeded the limit.
Managing a Health Savings Account
Health savings account funding and distribution rules are flexible, which provides an opportunity to develop strategies for managing the account that best fits your unique financial situation and goals. Deciding how much to contribute and when to contribute and make withdrawals, when possible, is all part of the strategy to maximizing the return of your HSA.
Make Deposits Only After Qualified Expenses Occur:
If you have limited cash availability, or prefer to use other investments, you can contribute just enough money to pay your qualified medical expenses using pre-tax money. When you have a qualified expense, you deposit the money to cover it and either withdraw it immediately for the expense. If you choose this strategy of managing your account, you will want an administrator with low fees and low minimum balance requirements.
Use the HSA as Tax-Advantaged Savings:
Another strategy is to contribute the maximum amount annually and leave the money in the account until you are 65 years old. Doing this means you pay for all health care expenses, including qualified expenses, with after-tax money instead of pre-tax money. If you choose this strategy of managing your HSA, you will want an administrator that offers a wide variety of investment options to maximize your growth potential.
To maximize growth of health savings account funds, make your contributions as early in the tax year as you can. Alternatively, you could wait until the April tax filing deadline to make your HSA contribution for the previous year to minimize the amount of time your money is locked up.
Balanced Use of HSA:
This strategy of managing your health savings account involves funding your account to the maximum annual contribution limits or as much as your budget allows, and then paying qualified health expenses directly from your HSA. With this strategy, any money contributed that is not needed for health expenses would remain in the account as tax-advantaged savings. Using this strategy is what the federal government had in mind when the health savings account was created in 2003, and it allows individuals to maximize their tax deduction while at the same time minimizing out of pocket expenses for health care. The majority of people with HSAs use the balanced strategy for getting the most out of their account.
Leaving your money in the account as long as possible before reimbursing yourself for qualified expenses is another way to increase growth of your HSA. Keep good records so you can match any withdrawals from your HSA with qualified medical expenses.
When your HSA balance has grown, you may consider increasing your health insurance deductible so you can reduce the amount you pay for your health insurance premiums. Without money saved, higher deductibles for health care are risky, but if you have enough money in an HSA to cover the higher deductible, you can save several thousand dollars annually on your health insurance premiums.
This is a guest post by Jeff Rose. Jeff Rose is an Illinois Certified Financial Planner and co-founder of Alliance Investment Planning Group. He is also the author of Good Financial Cents, a financial planning and investment blog and he is currently working on his first book entitled Soldier of Finance. You can see more about his mission at the same titled blog Soldier of Finance.com.