Health Savings Accounts (HSAs)

Health Savings Accounts (HSAs)

Health Savings Accounts (HSAs) are tax-free savings accounts for people covered under High-Deductible Health Plans (HDHPs). Individuals enrolled in HSAs can manage their healthcare expenses by setting aside pre-tax money to pay for qualified medical expenses.

Definition and Eligibility Criteria

HSAs are tax-advantaged accounts that can pay for qualified expenses such as dental care, prescription medications, contacts and eyeglasses, x-rays, bandages, and co-pays.

HSAs can save you tax dollars as contributions to the savings account reduce your taxable income. In addition, you won't need to pay tax on the money in the account even when it earns investment returns or interest.

HSAs are triple-tax advantaged because:

  • Contributions made in the account are not taxable.
  • Money in the account can be invested tax-free.
  • Money withdrawn from the account is not taxable when using it to pay for qualified medical expenses.

HSA Eligibility Criteria

You can be eligible to enroll in an HSA if:

  • You have a qualified high-deductible health plan (HDHP).
  • You do not have any other health coverage.
  • You do not use Medicare.
  • You do not claim to be a dependent on someone else's tax return.

To open a Health Savings Account (HSA), you can either look at certain financial institutions or benefit from an employer-sponsored plan that allows employer and employee contributions. Additionally, eligible individuals can have contributions made by another person, such as a family member.

Self-employed or unemployed individuals can also enroll in an HSA if they meet the eligibility requirements.

HSA Special Considerations

HSAs are available to people covered by high-deductible health plans (HDHP). With an annual high-deductible health plan, you pay more for your healthcare services before the insurance plan pays. However, these plans come with a lower monthly premium than other health plans.

How Does the HSA-Eligible Plan Work?

  • An individual enrolled in an HSA-eligible plan will pay a lower monthly premium but have a higher deductible.
  • Individuals use the money in the HSA to pay deductibles and other qualified medical expenses, such as co-insurance and co-payments.
  • People who do not need many health care services can save money by paying a lower premium.
  • If they need more healthcare or services, they can use the tax-free money in the HSA.

Any balance in the HSA rolls over from year to year, so you can build reserves to pay for future health services.

An HSA-eligible plan must set:

  • A minimum deductible: The amount to pay annually before the insurance starts to pay.
  • A maximum out-of-pocket cost: An individual must pay the maximum yearly if more healthcare services are required.

Tax Advantages and Contribution Limits

Tax Advantages of an HSA:

HSAs can offer some tax advantages.

  • Contribution tax advantages: HSA contributions do not count toward an individual's taxable income.
  • Distribution tax advantages: Distributions of funds from HSAs are tax-free, provided they are for qualified medical expenses.

HSA Contribution Limits

Eligible individuals can only accept cash contributions to their HSAs. In 2024, the maximum amount an individual can contribute to an HSA is $4,150 ($8,300 for a family). Individuals aged 55 and above can make an additional $1,000 catch-up contribution to their HSAs.

HSA Contribution Rules

Any unused HSA contributions will roll over to the new year. In addition, an HSA is portable, meaning you'll keep it if your job changes.

HSA plans can be transferred tax-free to a surviving spouse upon the account holder's death.

However, when the beneficiary is not the account holder's spouse, the beneficiary is taxed on the account's fair market value after adjusting for any qualified medical expenses of the deceased, paid from the account within one year of death.

Qualified Medical Expenses and Withdrawal Rules

You can use your HSA for qualified medical expenses to benefit from a tax-free withdrawal. Qualified medical expenses may include:

  • Co-pays
  • Prescription drugs
  • Dental services
  • Vision care
  • Deductibles
  • Psychiatric treatments
  • Other expenses not covered by a health insurance plan

Insurance premiums do not qualify for the qualified medical expenses unless the premium is for:

  • Medicare or other healthcare coverage, such as continuation coverage (COBRA), provided you are 65 years or older.
  • Coverage when receiving unemployment compensation.
  • Long-term care insurance is subject to annually adjusted limits.

Premiums for Medigap or Medicare supplemental policies are not considered qualified medical expenses.

HSA distributions for purposes other than qualified medical expenses will be taxable under income tax with an additional 20% tax penalty. However, those over 65 will not suffer a tax penalty, and only income tax will apply to non-qualified withdrawals.

Takeaway

HSAs are considered one of the best savings and investment tools, with potential financial benefits. Enrolling in an HSA allows you to use pre-tax dollars to pay for qualified medical expenses and retirement benefits.

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