What is a Health Savings Account and Do the Potential Drawbacks Outweigh the Tax Advantages
Health Savings Accounts are used with high-deductible health insurance plans and are tax deductible, but they do carry some risks
A Health Savings Account (HSA) is a type of savings account that lets you set aside money on a pre-tax basis in order to pay for qualified medical expenses. When you use pre-taxed dollars to pay for your deductibles, copayments, coinsurance, and some other expenses, you are able to lower your overall health care costs by lowering your taxable income. It's a good way to save, but not for everyone.
What is a Health Savings Account?
A health savings account is one type of medical-related savings plan. You can use money in your HSA to pay for medical costs that your health insurance doesn't cover, including co-payments, deductibles, and other qualified expenses.
Do I Qualify?
In order to qualify for participation in an HSA, you must be enrolled in a high-deductible insurance plan as defined by the Internal Revenue Service (IRS). Each year the IRS determines the minimum deductible the insurance plan must have and the maximum out-of-pocket amount in order for the plan to qualify. Unfortunately, not all high-deductible plans qualify you for an HSA. In order to know for sure, your plan should state specifically that it is eligible for HSA. However, if you have a high-deductible plan and any other plan that is not a high-deductible plan, you won't qualify for an HSA.
For 2020, the IRS has determined that a health insurance plan must have a minimum annual deductible of $1,400 and a maximum out-of-pocket amount of $6,900 for self-only coverage or a minimum annual deductible of $2,800 and a maximum out-of-pocket amount of $13,800 for family coverage.
How Does it Work?
Whether you get your HSA through your employer or on your own, you decide each year how much money you want to contribute to your HSA up to the government maximums, which is up to $3,550 for self-only coverage and up to $7,100 for family coverage. You then receive a debit card or checks linked to this account which you can use to pay for qualified expenses. Any unused balance rolls over into the next year, so you don't have to worry about forfeiture like you do with Flexible Spending Accounts.
HSAs have a number of advantages that make them attractive, including:
- Most medical expenses qualify to be paid with an HSA.
- Anyone can contribute to your HSA up to the limits, whether it's you, your employer, a family member, or even a stranger.
- Contributions to HSAs can be pre-taxed through payroll deduction, which could give you significant tax benefits.
- If you don't contribute pre-tax, contributions later are tax-deductible.
- Withdrawals are not subject to federal taxes and sometimes state taxes if used for qualifying expenses.
- Interest earned is not taxed.
- Unused money rolls over into the next year.
- Even if you change health plans, change employers, or even retire, the money in the HSA is still yours.
- Most HSAs issue you a debit card to use for payment, which makes it easy to pay for the things you need.
- They allow you to reduce your tax liability if you otherwise wouldn't itemize or not qualify to deduct medical expenses on your tax return.
HSAs have a number of disadvantages that might make them a bad option for you, including:
- You must have a high-deductible insurance plan in order to contribute, which puts more burden on you than other insurance types.
- Those with HSAs report feeling reluctant to seek health care due to having to spend the money they have saved.
- You can always withdraw money, but it will be subject to taxes if used for non-qualified expenses and a 20% penalty if you are under age 65.
- You have to keep records and receipts to prove your withdrawals were used for qualified expenses.
- Some HSAs charge monthly fees or transaction fees, which do cut into your potential tax savings.
Expenses incurred before you establish an HSA aren't qualified medical expenses. Each state has laws that determines when an HSA is established. Qualified expenses typically include health plan copayments, dental work and orthodontia, eyeglasses and contact lenses, and prescriptions.
Qualified medical expenses are those incurred by you, your spouse, and dependents claimed on your tax return. Medical expenses may be qualified for a person if you could have claimed that person as a dependent. In these cases, the exception is if the person filed a joint return, the person had gross income of $4,200 or more, or if you or your spouse filing jointly could be claimed as a dependent on someone else's return.
When dealing with an HSA, you want to be a packrat with paperwork and documentation. Keep each and every receipt, HSA statement, records of employer contributions, and any documents that explain your services. If you can't prove the expense was qualified, you can find yourself paying tax on the amount in question plus a 20% penalty. In addition to submitting a detailed receipt, you will be required to submit the prescription you receive from your doctor. It must be written by your doctor on a pad or form and must be dated on or before the date of the expense. Some over-the-counter medications will need a prescription. Additionally, you may need a Letter of Medical Necessity to verify a treatment is medically necessary and for a known health condition.
If you have questions about HSAs, including whether an expense is qualified, contact your account administrator or the IRS.