What Is a Health Savings Account?
A health savings account (HSA) is a type of account that you can put money into to save for health-related expenses on a tax-free basis.
You can contribute to a health savings account only if you:
- have a high deductible health plan (HDHP)
- have no other medical insurance coverage, including Medicare – however, you are permitted to have other types of health-related insurance, such as accident, disability, dental care, vision care, or long-term care
- cannot be claimed as a dependent on someone else’s tax return
Both you and your employer can make contributions to your HSA. However, the total amount of the contributions cannot be more than an annual limit set by the government.
For 2010, if you have HDHP coverage only for yourself, you can contribute up to $3,050. If you have family HDHP coverage you can contribute up to $6,150.
Any contributions made to your HSA must be cash; contributions of stock or property are not allowed. Also, you cannot make any contributions to your HSA when you enroll in Medicare. However, you can keep the money in your HSA and use it to pay for medical expenses tax-free.
According to the Internal Revenue Service (IRS), HSAs have the following tax-related advantages:
- You can claim a tax deduction for contributions you or someone other than your employer, make to your HSA.
- Contributions to your HSA made by your employer may be excluded from your gross income.
- Any interest or other earnings you make on the money in your HSA are tax free.
- Money that you take out of your HSA may be tax free if you pay “qualified” medical expenses.
You can find details about the tax benefits and rules (including examples of how HSAs work) in IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.
Signing Up for an HSA
Banks, credit unions, insurance companies and other financial institutions are permitted offer and oversee HSA accounts. Your employer may also have set up a plan that will help you sign up. Note that your HSA is not something you purchase; it’s a savings account into which you can deposit money on a tax-preferred basis.
What Is a High-Deductible Health Plan?
If you decide to open an HSA, you must have a high-deductible health plan (HDHP). An HDHP is an inexpensive (or less expensive) type of health insurance that does not cover you for the first several thousand dollars of health care expenses but typically will cover you after that.
You can use your health savings account to help pay for the expenses your health plan does not cover.
A Dr. Mike Definition: Deductible - A deductible is the amount you must pay out-of-pocket each year for health-related expenses before your insurance policy begins to pay. There is a wide range of deductibles - anywhere from none to $10,000 a year or more.
In order to qualify to open an HSA in 2010, your HDHP minimum deductible must be at least $1,200 for self-only coverage or $2,400 for family coverage. Your annual out-of-pocket expenses, including your deductible and co-payments for 2010 cannot exceed $5,950 for self-only coverage or $11,900 for family coverage.
The amount of the required deductible and out-of-pocket expenses is adjusted annually to account for inflation.
Enrolling in a High-Deductible Health Plan
Any company that sells health insurance in your state may offer an HDHP. Your employer may offer an appropriate plan and you also should be able to find a qualified HDHP by contacting your current insurance company, or an agent or broker licensed to sell health insurance in your state. Your state insurance department may also be able to provide information about qualified HDHPs.
What are Qualified Medical Expenses?
IRS Publication 502 defines qualified medical expenses as "the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body. These expenses include payments for medical services rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes."
A Dr. Mike Tip: Although non-prescription medicines (other than insulin) do not qualify for the medical and dental expenses deduction, they do qualify as expenses for HSA purposes.
What Are the Pros and Cons of Health Savings Accounts?
The U.S. Treasury Department states that the advantages of HSAs include:
- They provide security by protecting you against high or unexpected medical bills.
- They may be more affordable due to lower health insurance premiums.
- You have the flexibility to use the funds in your account to pay for current medical expenses, including expenses that your insurance may not cover.
- You can save the money in your account for future medical expenses.
- You can grow your account through investment earnings.
- You make all the decisions about how much money to put into your account, whether to save the money for future expenses or pay current medical expenses, and which medical expenses to pay.
- You can keep your HSA even if you change jobs, change your medical coverage, become unemployed, move to another state, or change your marital status.
- Your funds remain in the account from year to year – there are no “use it or lose it” rules
Additionally, your HSA provides you triple tax savings:
- tax deductions when you contribute to your account
- tax-free earnings through investment
- tax-free withdrawals for qualified medical expenses
The health reform legislation (Patient Protection and Affordable Care Act) signed into law in March 2010 makes some changes to how you manage your HSA. Starting January 1, 2011, you can no longer be reimbursed on a tax-free basis for the costs of over-the-counter medications. And, the tax on distributions from your HSA that is not used for qualified medical expenses will increase from 10% to 20%.
A number of consumer organizations, including Consumers Union, the publisher of Consumer Reports, have been critical of HSAs because they provide the greatest benefit to young healthy people who do not have dependents and wealthy people who can save more on their taxes.