Is a Health Savings Account (HSA) Right for You?
Compliments of The Litherland, Kennedy & Associates, APC, Attorneys at Law
Written By: The American Academy of Estate Planning Attorneys
The American health care system has gone through some significant changes in recent years. One thing that did not change, however, is the potential to save both money and taxes by opening a Health Savings Account, or HSA. For those who qualify, an HSA allows you to save money tax-free that can be used for health care related expenses.
Who Qualifies for a Health Savings Account?
To qualify for an HSA you must meet all of the following criteria:
- You must be covered by a “high-deductible health plan”
- You must not be covered by another health plan
- You must not be eligible to be claimed as a dependent on another person’s tax return
- You must not be entitled to Medicare benefits
What Is a High-Deductible Health Plan?
To be eligible for a HSA you must be covered by a health insurance plan that qualifies as a “high-deductible health plan,” or HDHP. As of 2016, an individual coverage HDHP must have an annual deductible of at least $1,300 and require that annual out-of-pocket expenses paid (including co-payments and deductibles but not insurance premiums) not exceed $6,550. If you have a family coverage plan, the limits are an annual deductible of not less than $2,600 and the plan must require that out-of-pocket expenses not exceed $13,100.
Getting Started with an HSA
Opening an HSA is relatively easy. You do not need to go through your current health insurance provider nor employer to open an HSA. An HSA is independently owned by you. It can be set up with any qualified trustee or custodian, such as your bank. Opening an HSA is much the same as opening an individual retirement account (IRA). There are, however, rules about how much you can contribute to your HSA each year. As an individual, your contributions are limited to $3,350 per year. A family account allows for contributions up to $6,750 per year. If you are age 55 or older, however, you may contribute an additional $1,000 per year, increasing the maximum contributions to $4,350 for an individual and $7,750 for a family account. If your employer sets up your HSA, both you and your employer may make contributions. Keep in mind that the contribution limits are subject to change from year to year to adjust for inflation.
Spending Your HSA Funds
The purpose of an HSA is to pay for health care-related expenses that are not covered by an existing policy. You may spend your HSA funds on any “qualified medical expense” which includes medical care, prescription drugs, and payment for long-term care. Examples of expenses that would likely be covered include:
- Doctor visits
- Ambulance costs
- Vision care
- Lab fees
- Certain premiums for health care insurance
How Does an HSA Save Money on Taxes?
An HSA can be likened to a traditional IRA or a Roth IRA in that they all allow you to save money for a rainy day. With a traditional IRA, however, you receive a tax deduction when you make contributions to the fund but you are then taxed when you withdraw the funds. A Roth IRA does not provide a tax deduction when you make contributions, but is also not taxed when you make withdrawals. An HSA provides you with the best of both worlds. Contributions to your HSA are tax-deductible while qualified distributions are not taxable. In essence, you are able to grow the funds held in your HSA tax-free. By way of illustration, imagine you are in a 30% tax bracket. If so, a $1,000 contribution would really cost you $700 after taxes. If you invested that same $1,000 in an HSA earning 7.2% interest for 10 years, your investment would grow to $2,000. If that $2,000 is then used to pay for qualified medical expenses, you would effectively avoid paying any taxes on the $1,000 earned on your investment.
What Happens If You Never Need the Funds Held in Your HSA?
You could be fortunate enough to never need any of the funds held in your HSA. If that occurs, you can withdraw the funds; however, distributions made for anything other than a qualified medical expense will be taxed and will incur a 20% penalty. After age 65, you can make withdrawals without incurring a penalty, though the funds will be taxed as ordinary income.
For those who qualify, an HSA is an excellent savings and tax avoidance vehicle that provides the benefits of both a traditional IRA and a Roth IRA all-in-one. Consult with an experienced estate planning attorney in your area for additional information and to help you determine if an HSA fits into your overall estate planning goals and objectives.