Health Savings Accounts

What is a Health Savings Account?

A Health Savings Account, or HSA, is a tax exempt account with a financial institution (usually a bank or insurance company), called a "trustee", in which you accumulate savings to pay for medical expenses that aren't covered by a traditional health insurance plan. They work together with a high deductible health insurance plan.

Starting in 2004, eligible individuals and families were able to slash their federal income tax bills by making deductible HSA contributions. This will be like making deductible IRA contributions. Even better, you can qualify for the HSA break regardless of your income since there are no nasty phase-out rules for high earners like the ones that apply to a traditional IRA.

Similar plans were previously referred to as Medical Savings Accounts.  The new HSA tax law made significant changes  to the MSA.  The plans are now available to more people than before.  

You deposit money into your Health Savings Account as often as you need. Amounts that have accumulated are intended to be withdrawn and used to pay for actual medical expenses, such as doctor visits, prescriptions, etc. that your health insurance plan doesn't cover until you reach your deductible.

You get a tax deduction for money contributed to the account each year. Then you pay your medical expenses by withdrawing funds from the account. If expenses exceed your health insurance policy deductible, the policy pays the additional costs. If you spend less than the amount contributed, the difference stays in the account and earns interest. No use it or lose it provision!

The HSA account can have features of both a savings and a checking account, where you can have checks and debit cards, but is not a savings or checking account in the strict sense due to tax and legal regulations.

 Do I qualify for an HSA?

Now nearly everyone maintaining an individual or family high deductible health plan will be eligible to get an HSA. Partners and 2% Subchapter S shareholders as well as Sole Proprietorships are eligible. Also, an employee of a small business (50 or less employees) that maintains an individual or family high deductible health plan.

An individual is ineligible for an HSA if the individual is covered under a health plan that is not a high deductible health plan.

What is a High Deductible Health  Insurance Plan?

A high deductible health plan is a plan that has either (a) An annual deductible of at least $1,000.00 and not more than $2,700.00 for individual coverage for tax year 2006; or (b) An annual deductible of at least $2,000.00 and not more than $5,450.00 for family coverage for tax year 2006.

A high deductible health plan has a higher annual deductible than typical health plans, and a maximum limit on the annual out of pocket expenses. Monthly, quarterly, or annual premiums are generally much lower with a high deductible health plan.

How Can I Benefit from an HSA?   
You may enjoy several benefits from having an HSA.

You can claim a tax deduction for contributions you, or someone other than your employer, make to your HSA even if you do not itemize your deductions on Form 1040.

Contributions to your HSA made by your employer (including contributions made through a cafeteria plan) may be excluded from your gross income.

The contributions remain in your account from year to year until you use them.

The interest or other earnings on the assets in the account are tax free.

Distributions may be tax free if you pay qualified medical expenses.

An HSA is “portable” so it stays with you if you change employers or leave the work force.

 

How Much Can I Contributed to an HSA?

The maximum annual amount permitted to be contributed in order to qualify for a tax deduction to an HSA for a year is 100% of the deductible for individual and/or family coverage (a family is more than one person).

Example 1: Individual

Individual has coverage with a high deductible health plan with an annual deductible of $2,000.00. The annual contribution limit this individual can make is 100% or $2,000.00, up to a maximum of $2,700.00.

Example 2: Family

Family has coverage with a high deductible health plan with an annual deductible of $4,000.00. The annual contribution limit is 100% or $4,000.00, up to a maximum of $5,450.00.

The contribution cannot exceed annual earnings.

Generally, HSA holders must pay 6% excise tax on contributions to an  HSA that are greater than the limit. The owner may withdraw the excess without paying the excise tax if they withdraw by the due date of the tax return and withdraw any income earned on the excess.

No minimum contributions are required except to cover an annual custodian fee.

Why an HSA?

The advantage to an HSA is that the individual gets to keep the amount that is not spent in the account. Let's assume someone puts $3000 in their account for the year and only uses $1000 of medical services, they get to keep the additional $2000 (in their account). The amount is not lost and rolls over to the next year. The funds in the account will continue to grow until you need them for medical expenses or you reach age 65.

How Much Can I Save?

Here are two examples of how an HSA can save you money:

Example 1 -  Average Scenario: Family of four - Father is 45, self employed; Mother is 42; two kids. This displays out of pocket expenses with and without an HSA. Estimated annual medical expenses are $1500 -  $900 for father, $300 for mother, $100 for one child one and $200 for the other child.

	Traditional Plan		HSA Plan
	Expenses  Without HSA	Savings  Without HSA	Expenses  With HSA	Savings  With HSA
Plan Specifications	Deductible: $500 Coinsurance: 80/20		Deductible: $5000 Coinsurance: 0
Estimated Annual Medical Expenses	$1500		$1500
Annual Premiums (A)	$7400		$3175
HSA Contribution (B)	+       $0		+  $3000
Tax Savings on Premium: Premium: Tax Rate: Allowable Deduction (C)	$7400 x      .33	-         $2442	$3175 x     .33	-          $1047
Tax Savings on HSA: HSA Contribution: Tax Rate: HSA Tax Deduction (D)	0 x      .33	-               $0	$3000 x     .33	-          $990
Out of Pocket to Cover Deductible: (E)	+    $1100		+      $0
Out of Pocket to Cover Coinsurance (F)	+       $ 80		+      $0
Total Out of Pocket Costs  =(A+B) - (C+D) + (E+F)	$6138		$4138
Amount of Current Year HSA Contribution Not Spent (You keep)			$1500

*FYI: The $1500 of medical expenses will be taken out of the HSA contribution already accounted for in (B).

 

Synopsis Example 1: The total out of pocket expenses without the HSA is $6,138. The net cost for the HSA plan is $2638 ($4138 - $1500). This is a savings of $3500! Go to blank worksheet to estimate your savings.

Example 2 -  Worst Case Scenario: Family of four - Husband is 47, self employed; wife is 44; two children. This example compares out of pocket expenses with and without an HSA. Estimated annual medical expenses are $75,000. $400 for husband, $74,400 for wife, $200 for child one, $0 for child two.

	Traditional Plan		HSA Plan
	Expenses  Without HSA	Savings  Without HSA	Expenses  With HSA	Savings  With HSA
Plan Specifications	Deductible: $500 Coinsurance: 80/20		Deductible: $5000 Coinsurance: 0
Estimated Annual Medical Expenses	$75,000		$75,000
Annual Premiums	$7400		$3175
HSA Contribution	+           0		+   $3000
Tax Savings on Premium: Premium: Tax Rate: Allowable Deduction:	$7400 x        .33	-         $1700	$3175 x     .33	-          $1047
Tax Savings on HSA: HSA Contribution: Tax Rate:	0 x        .33	-               $0	$3000 x     .33	-          $990
Out of Pocket to Cover Deductible:	+    $1100		+ $2000
Out of Pocket to Cover Coinsurance	+      $900		+      $0
Total Out of Pocket Costs	$6958		$6138
Amount of Current Year HSA Contribution Not Spent			$0

 

Synopsis Example 2: The total out of pocket expense without the HSA is $6958. The net cost for the HSA plan in $6138. This is a savings of $820. This shows that the worst case scenario still produces a savings.

 

How Do Distributions Work?

HSA owners can make a withdrawal (also called a distribution) at any time when used for qualified medical expenses.

Depending on the custodian, you may need to fill out a form requesting a withdrawal, request an electronic funds transfer to another account, such as a personal checking or debit card account.

HSA custodians are not required to determine whether HSA distributions are used for medical expenses. The owner is responsible for this. Federal Tax Form 8853, Part III is filled out to prove withdrawals for qualified medical expenses.

HSA owners can also pay for health care service provided or prescription drugs from their personal resources (savings or checking account), and can then reimburse themselves by removing funds from the HSA.

The penalty for non-qualified withdrawals before age 65 from an HSA is 10% plus the normal tax rate.

Any contribution that exceeds the limits stated above are not tax deductible.

How Can an HSA Be Established?

Any eligible person can establish an HSA with a qualified trustee or custodian. You do not need permission from your health insurance carrier or from the IRS before establishing an HSA.

Any insurance company or bank can be a trustee or custodian if they offer that service. Also, individuals who are approved to create and maintain IRAs, such as a financial advisor, are automatically approved to be a custodian or trustee.

Contact an HSA administrator to sign up for an HSA. In most cases an application is filled out and submitted, possibly along with other eligibility forms. Remember, you must have a qualifying high deductible health insurance plan in place to set up your HSA.