HSA? IDK!: An Explanation of Health Savings Accounts

HSA-IDK-final Health Savings Accounts, also known as HSAs, are triple tax-free accounts which can help users cover their out-of-pocket medical costs. They are triple tax-free because the money goes into this account pre-tax, grows tax-deferred and can then be withdrawn tax-free to pay unreimbursed medical expenses, including deductibles and health costs that aren’t covered by insurance. An additional bonus is that HSAs can also help to boost retirement savings.

Who can/should sign up?

With so many benefits included in an HSA, it’s easy to assume that everyone should be using this type of account; however, there are some parameters around who can and cannot use an HSA. You cannot be enrolled in Medicare or be claimed as a dependent on another person’s tax return and participate in an HSA. Also, anyone who is an employee, self-employed, or an individual must be covered by a High Deductible Health Plan (HDHP) in order to establish an HSA.

An HDHP is a medical insurance plan that has a higher than average specified minimum deductible - typically at least $1,250 for individuals and $2,500 for families. Ultimately, an HSA is most appealing to an individual or family that has a relatively modest medical care expenses, can afford a high-deductible medical plan, and can take advantage of the substantial tax benefits of a health savings account.

If you qualify for and opt into an HSA, as of 2015 there is a limit of $3,300 that can be contributed to this plan for singles under 55, and $6,550 for families under 55. For those over 55, the maximums are $5,250 and $8,450 respectively. Carriers may offer a suggested banking institution who can set up your account. Your own bank may offer to be your account custodian, and online banks may offer these types of accounts as well.

HSA versus FSA

It’s important to know the difference between an HSA and the similar sounding FSA (Flexible Spending Account). Both accounts are used to pay health bills with pre-tax dollars, but there are two major differences. First, an HSA allows you to roll over any money that you do not spend by December 31st. Secondly, after age 65, you can withdraw your savings from an HSA for nonmedical expenses without owing a tax penalty. Those withdrawals are, however, taxed as income like a traditional IRA.

A FSA, on the other hand, is a use-it-or-lose-it account, meaning if you don’t spend the money you’ve put into it before the year’s end it is absorbed back into your company’s fund. This account can be helpful for families who have a higher premium and lower deductible healthcare plan, but who still expect to incur yearly medical expenses and want to lower their taxable income.

Do’s and don’ts for using an HSA

If you have an HSA, it’s important to know the many ways you can and cannot utilize your account. It’s not just for emergency room visits, but don’t go on a shopping spree with this account.

  1. Use your HSA to pay for prescription medications, including those sold over-the-counter. The exception to this is insulin which now does not require a prescription to utilize your HSA.
  1. Using your HSA should be as simple as using your checking account. You can receive blank checks, a debit card, or both to pay for purchases using your HSA.
  1. Nontraditional medical services, like acupuncture and massages, can qualify as legitimate HSA expenses. Just be sure they’re permitted by your high-deductible heath plan and that you have a prescription from your doctor.
  1. Keep your receipts and records associated with your purchases from your HSA. If the IRS audits you about your HSA before you’re 65, you’ll need to prove the account was used appropriately. The full list of rules can be found in IRS Publication 969, but two commonly confused expenses that you can’t pay for with your HSA are health insurance premiums and cosmetic surgery.
  1. Avoid using your HSA for non-medical expenses before 65. There is a 20% tax on the amount that’s withdrawn if you pull money out of your account for inappropriate expenses.
  1. An HSA is a great option to consider if you’re already maxing out your yearly contributions to your pre-tax retirement accounts. You’ll be continuing to save for retirement tax-free.
  1. Once you reach age 65, you can make penalty-free withdrawals. At this age, though, you can no longer contribute to an HSA.
  1. Your investing strategy might be different with an HSA than your other retirement accounts. The purpose of an HSA is to pay for medical expenses, so it’s important to have balanced risk in your HSA investments regardless of your age. You don’t want to have a medical emergency and no money in your HSA to pay for it because of a volatile market.