With costs associated with medical treatments and health insurance premiums rising each year, health care consumers might want to consider enrolling in a high-deductible health insurance plan.  They might also consider establishing a health savings account (HSA) to pay for qualifying out-of-pocket medical expenses using tax-free dollars.

HSAs offer a variety of tax advantages depending on your age, income and whether you have individual or family coverage. To qualify, you must be covered under a high-deductible health insurance plan, as defined by the Internal Revenue Service (IRS).

What is a Health Savings Account or “HSA”?

An HSA is a tax-exempt trust or custodial account you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur. You must be an eligible individual to qualify for an HSA. An HSA can be set up at your local bank that offers HSA accounts and it can work like a typical checking account. The bank will provide a book of checks and a debit card so you can easily access funds in the account to pay for medical expenses. No permission or authorization from the IRS is necessary to establish an HSA. 

Who can set up a HSA?  What are the benefits and how do I contribute?

To be an eligible individual and qualify for an HSA, you must meet the following requirements:

  • You are covered under a high deductible health plan on the first day of the month
  • You have no other health coverage except what is permitted by IRS rules
  • You aren’t enrolled in Medicare
  • You can’t be claimed as a dependent on someone else's tax return.

HSAs offer several benefits, such as:

  • You can claim a tax deduction for contributions you, or someone other than your employer, make to your HSA even if you don’t itemize your deductions
  • Contributions to your HSA made by your employer (including contributions made through a cafeteria plan) may be excluded from your gross income
  • The contributions remain in your account until you use them
  • The interest or other earnings on the assets in the account are tax free
  • Distributions may be tax free if you pay for qualified medical expenses
  • An HSA is “portable”( It stays with you if you change employers or leave the work force)

In essence, an HSA is a way to accumulate tax-free money to pay for medical expenses not covered by a high-deductible health insurance plan. A high-deductible health insurance plan typically has much lower monthly premiums when compared to more standard plans so pairing it with an HSA can be a way to effectively manage your health care expenses while realizing substantial savings in taxes and premiums.

Any eligible individual can contribute cash to an HSA. Cash contributions can be made by depositing cash into the HSA just as you would a typical checking account. If you set up an HSA in combination with a high-deductible health insurance plan offered by your employer, the employee, the employee's employer, or both may contribute to the employee's HSA in the same year. This can be accomplished thru your employer’s payroll. For an HSA established by a self-employed (or unemployed) individual, the individual can contribute. Family members or any other person may also make contributions on behalf of an eligible individual.

For 2018, the HSA contribution limit (employer + employee) for self-only policy is $3,450 and for a family it is $6,900. Individuals age 55 or older can make yearly catch-up contributions of $1,000.

How do I take cash out of my HSA to pay medical bills?

You generally will pay medical expenses during the year without being reimbursed by your high-deductible health insurance plan until you reach the annual deductible for the plan. When you pay medical expenses during the year that aren’t reimbursed by your high-deductible health insurance plan  you can access the cash in your HSA just as you would with any checking account by writing checks or using a bank issued debit card associated with the HSA account.  

Writing checks against the funds in your HAS, or accessing the funds with a debit card, are distributions from the HSA. The distributions from your HSA are tax-free distributions as long as you pay for, or are being reimbursed for, qualified medical expenses you incur after you establish the HSA. If you receive distributions for other reasons, the amount you withdraw will be subject to income tax and may be subject to an additional 20% penalty tax. You don’t have to make distributions from your HSA each year.

What are qualified medical expenses? 

Qualified medical expenses are those expenses that generally would qualify for medical and dental expense deductions. (However, you can’t deduct qualified medical expenses as an itemized deduction that are equal to the tax-free distribution from your HSA) Also, non-prescription medicines (other than insulin) aren’t considered qualified medical expenses for HSA purposes. A medicine or drug will be a qualified medical expense for HSA purposes only if the medicine or drug requires a prescription or is available without a prescription (an over-the-counter medicine or drug) and you get a prescription for it.  Typically, the qualified medical expenses are those incurred by you, your spouse and all dependents you claim on your tax return. 

With respect to insurance premiums, the IRS doesn’t allow these as qualified medical expenses unless the premiums are for long-term care insurance, health care continuation coverage (such as coverage under COBRA), health care coverage while receiving unemployment compensation under federal or state law, Medicare and other health care coverage if you were 65 or older (other than premiums for a Medicare supplemental policy). 

Conclusion

A Health Savings Account can be a great way to manage and take additional responsibility for your health care spending while at the same time realizing some real tax benefits.