Health Savings Accounts (“HSA”) first appeared in 2004 to help individuals save for current and future healthcare costs.  Since then, HSA eligible insurance plans have been one of the fastest growing insurance plans offered as companies and individuals look for ways to reduce the burden of rising health care costs.  The number of HSAs has grown exponentially since then, with more than 16 million accounts holding over $30 billion in cash and investments last year.  If you are looking into health care coverage options, setting up an HSA account can be a great tool to fund health care expenses.

Can anyone open an HSA?

An HSA is a savings account designed to help pay for health care expenses.  To qualify for an HSA account you must be covered under a high deductible health plan (HDHP), you cannot be enrolled in Medicare, and you cannot be claimed as a dependent on someone else’s tax return.  Under an HDHP, monthly premiums are typically less than other more traditional health plans which makes them appealing to people trying to minimize costs associated with health care.  High deductible health plans are intended to cover serious illness or injury and, with the exception of preventive care, an annual deductible must be met before any plan benefits are paid.  Some argue that these plans make people better consumers of health care because they must pay more out-of-pocket before the insurance kicks in.

The IRS establishes guidelines for what the minimum deductible amounts are in order to qualify as an HDHP and the maximum amount of out-of-pocket expenses that can be spent from an HSA account in a given year. To qualify as an HDHP, minimum annual deductibles are $1,300 for individual coverage or $2,600 for family coverage.  Annual out-of-pocket expenses (deductibles, copayments, and other amounts, but not premiums) cannot exceed $6,550 for individual coverage and $13,100 for family coverage.  For 2017, HSA holders can save up to $3,400 for an individual and $6,750 for a family (HSA holders age 55 and older get to save an extra $1,000 which means $4,400 for an individual and $7,750 for a family), all of which are tax deductible.

What are the benefits of an HSA?

HSA’s have similar qualities to traditional retirement accounts like 401ks and IRAs.  There are several benefits of having an HSA due to its tax-advantaged status:

• You can claim a tax deduction for contributions you make to your HSA even if you do not itemize. Unlike IRAs, there is no income limitation.  Above-the-line deductions like this reduce adjusted gross income, which can lower your exposure to the net investment income tax and phase-outs of exemptions and itemized deductions.
• Contributions to your HSA by your employer are excluded from your gross income up to your contribution limit (contributions you make + contributions your employer make cannot exceed the contribution limit).
• Contributions remain in your account and roll over each year until you use them.
• The money in your HSA can be invested similarly to traditional retirement accounts and any earnings or interest on the account are tax-free.
• An HSA is “portable”. This means that if you change employers or leave the work force, it stays with you.
• Withdrawals from an HSA are tax-free if you use the proceeds to pay qualified medical expenses (a list of what qualifies as medical expenses can be found here). Withdrawals can be used to pay medical expenses of family members not covered by your high deductible health care plan.  Generally, you cannot treat insurance premiums as qualified medical expenses unless the premiums are for:

1. Long-term care insurance
2. Health care continuation coverage (such as coverage under COBRA)
3. Health care coverage while receiving unemployment compensation under federal or state law.
4. Medicare and other health care coverage if you were 65 or older (other than premiums for a Medicare supplemental policy, such as Medigap). If you are not 65 or older, Medicare premiums for coverage of your spouse or a dependent (who is 65 or older) generally are not qualified medical expenses.

You also can fund an HSA by transferring funds from an individual retirement account (“IRA”).  You are allowed a one-time transfer of IRA assets and the amount may not exceed the contribution limits mentioned above.  With such a transfer, the distribution from the IRA is not taxable, but the contribution into the HSA is not deductible.

What are the disadvantages of an HSA?

There are a few drawbacks to consider when deciding if an HSA is right for you:

• Potential penalties – an HSA can only be used for qualified medical costs, otherwise you’ll get hit with a 20% penalty if you are under age 65.
• High deductible requirement – even though you are paying less in premiums each month, it could be difficult to come up with the cash to meet a high deductible.
• Pressure to save – May be reluctant to seek healthcare when you need it because you don’t want to draw money from your HSA account.
• Recordkeeping – you must keep receipts to prove that withdrawals were used for qualified expenses.
• Fees – some HSAs charge a monthly maintenance fee or per-transaction fee which varies by institution

What happens to the account if the owner of the HSA dies?

Like other tax-qualified accounts, an HSA must be titled individually, not jointly, so it is important to designate a beneficiary.  If the account holder’s spouse is the beneficiary, the account will transfer to the spouse and the spouse will be the new owner of the HSA.  If the beneficiary is anyone other than the spouse, the HSA ceases to be an HSA as the date of death, and the beneficiary is required to include the fair market value of the account in his or her income (remember, this money has never been taxed).  The taxable amount is reduced by any qualified medical expenses for the decedent that are paid by the beneficiary from the HSA account within one year of the date of death.  If no beneficiary designation is made, the HSA ceases to be an HSA upon death and the fair market value of assets is included in income on the decedent’s final tax return.

Should you use an HSA?

Health Savings Accounts can be a great fit for healthy individuals and families and especially high-income earners because of the many tax advantages.   For folks who can save up to the maximum amount annually in an HSA and pay their current medical expenses with other funds, this is a great way to save and invest for future medical expenses.  If your employee benefits include a health plan that qualifies for an HSA, you should consider how the plan would impact your household budget and savings to see if it is right for you.