Health savings accounts (HSAs) were created in 2003 as part of the Medicare Prescription Drug, Improvement, and Modernization Act signed into law by President George W. Bush. The HSA essentially replaced the medical savings account. HSAs are a common feature of high-deductible health plans (HDHPs), so we thought it would be good to take some time to discuss the ins and outs of these accounts.
The Benefits of Health Savings Accounts
A health savings account is a tax-exempt trust or custodial account that is usually set up through a bank or insurance company. To open an HSA, you must be covered under an HDHP, not enrolled in Medicare, not a dependent and not covered under another health plan that is not an HDHP. To qualify as a high-deductible health plan, the minimum annual deductible in 2014 was $1,250 for individual coverage and $2,500 for family coverage. That amount increases to $1,300 and $2,600, respectively, in 2015.
There are many benefits of having an HSA:
- Unlike a flexible spending account (FSA), the HSA is portable and can go with you when you leave your employer.
- Also, unlike the FSA, an HSA is not a “use it or lose it” account. HSA funds are yours to keep, use or invest. This can be a way to add to retirement benefits; it can also create estate planning considerations, such as making sure proper beneficiary designations are in place.
- Employer contributions to the HSA may be excluded from gross income.
- Interest and growth on investments are tax-free.
- Distributions from an HSA are tax-free if they are used for qualified medical expenses.
- You can also withdraw HSA dollars to pay for some of your long-term-care premiums if the policy is “qualified.” Tax-qualified plans have to meet certain federal guidelines to be considered qualified. According to the National Association of Insurance Commissioners, “You must be chronically ill. Also, the care must follow a plan that a licensed health care practitioner prescribes. You’re considered chronically ill if it’s expected that you’ll be unable to do at least two activities of daily living without substantial assistance from another person for at least 90 days. Another way you may be considered chronically ill is if you need substantial supervision to protect your health and safety because you have a cognitive impairment.” Most long-term-care policies are qualified. The amounts you can withdraw tax-free depend on your age. The limits are as follows:
Attained Age Before Close of Taxable Year 2015 40 or less $ 380 More than 40 but not more than 50 $ 710 More than 50 but not more than 60 $ 1,430 More than 60 but not more than 70 $ 3,800 More than 70 $ 4,750
- You can claim a tax deduction for contributions that you or anybody else makes without having to itemize deductions on Form 1040.
HSAs in 2015
Some things to consider for 2015:
- Just like an IRA, you have until April 15, 2015, to make your 2014 contribution. The maximum 2014 contribution is $3,300 for individuals plus an additional $1,000 if you are 55 or older in 2014.
- Let’s say that you started a new job on December 1, 2014, with a high-deductible health plan and HSA. The IRS considers you to be an eligible individual for the full year if you are an eligible individual on the first day of the last month of your tax year. However, if you had your HSA for the first six months of 2014, then you would be eligible to contribute only one-half of the contribution limit—$1,650 for an individual.
- You can make a full contribution for 2015 at the beginning of the year, which would be $3,350 for individuals and $6,650 for families. HSA providers tend to have account minimums to start investing HSA dollars in mutual funds, such as $2,000. However, it’s prudent to have the contributions deducted from your paycheck, which are not subject to income or FICA taxes. If you write a check to your HSA, your contribution will be tax-deductible on your 1040, but it will not escape FICA taxes.
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The Power of HSAs
The growth on the earnings in an HSA is very powerful. For example, let’s say a healthy individual contributes $3,350 annually for the next 30 years, and those contributions have an annual rate of return of 5%. The future value 30 years later would be $209,282. This individual could then use that money to pay for qualified medical expenses or Medicare premiums (such as Medicare Parts A and B, and Medicare HMO) or to supplement retirement income. HSA funds, however, cannot be used to purchase Medigap or Medicare supplemental policies.
Distributions from an HSA that are not used for qualified medical expenses will be included in your income and are subject to an additional 20% penalty. The tax can be figured on Form 8889. However, if the individual is 65 or older, then distributions not used for qualified medical expenses will be included as ordinary income but will not incur a 20% penalty.
In short, an HSA can be a powerful tool for funding medical expenses and saving for the future.
Disclaimer: Consult your tax advisor before taking any action on topics discussed in the blog.