Health Savings Accounts

by Craig Pellet, CPA

Unless your out-of-pocket medical expenses are very high relative to your income, it is unlikely that you can get a tax benefit from them, as IRS rules greatly limit the amount you can deduct. If you have a high-deductible health plan (HDHP), a Health Savings Account (HSA) is a great way to get around those limits. You get a deduction when you put money into an HSA. And so long as you spend the money on medical expenses, you do not pay tax when you take the money out again. And the premiums on a HDHP are typically lower than on a plan with a lower deductible.

How do I qualify for an HSA?

Only taxpayers who are covered by a high-deductible health plan can contribute to an HSA. As of 2016, a high deductible is defined as $1,300 or more for a self-only plan, and $2,600 or more for a family plan. These amounts are indexed for inflation. However, if you have other health insurance plans (excluding dental, vision, long-term, accident and disability) you do not qualify for an HSA. Medicare enrollees are not permitted to contribute to an HSA. Also, if you are a dependent on someone else’s return you cannot contribute to an HSA. That means that kids cannot have their own accounts. You should pay kids’ expenses from your own HSA if you qualify.

How much can I contribute?

Eligible individuals can contribute up to $3,350 to an HSA if they have self-only coverage, or $6,750 for family coverage in 2016. The contribution limits are indexed to inflation and are higher for folks 55 years or older.

Generally, partial years are prorated. If you are covered for 6 months on a family plan, you can contribute $3,375. There is an exception – if you are covered on December 1st, you are considered eligible for the full year. However, you must remain covered by an HDHP for all of the following calendar year, or you will have to give back some of the deduction.

My employer offers a flexible spending account (FSA). Is that the same thing?

No. Flexible spending accounts benefits employers can offer to employees, and are known for their “use it or lose it” rules. The contribution limits on an FSA are lower, at only $2,550.

While some employers do offer HSA contributions as part of compensation packages, that is not the only way to get an HSA. You can generally open an account the same way as any other bank account.

How do I get this deduction?

You get a deduction when you contribute money to an HSA, not when you pay for medical expenses. That means you can save now for future medical expenses by contributing to an HSA. Usually the HSA will earn a bit of interest, which is tax-free as well.

At the end of the calendar year, your HSA provider should send you three statements: a 1099-SA (showing total distributions), a 1098-SA (showing contributions), and a 5498-SA (showing the year end value of the account). All three are important for your tax return. Most banks will also summarize all of this information on a single statement, which is very useful. When you file your return you will compile all of this information on Form 8889.

It is important to note that if you withdraw more from the HSA than you spend on medical costs you will owe tax on the excess withdrawn, along with a 10% penalty.

What expenses can be paid for out of an HSA?

Any qualified medical expenses can be paid using funds in an HSA. This includes co-pays, hospital bills, dental expenses and prescription drugs. Generally, you cannot use HSA funds for general health expenses like a gym, yoga, a health club or over-the-counter drugs. HSA funds can be used for medical expenses of the taxpayer, his or her spouse and dependents.

Where can I open an HSA?

Most commercial banks and some brokerage firms offer HSA accounts. Consider if you’ll be using your HSA to save for future expenses or to pay for current ones. If you are saving, you might consider a brokerage firm that offers investments with higher returns than the savings rate offered by a commercial bank. Indeed, you could choose to fund an HSA, invest the funds, and pay out-of-pocket costs with other cash. That way, the balance in the HSA would build up, a lot like a retirement account.

John Schachter + Associates Inc. helps clients recognize the opportunities for tax savings with HSAs. Talk to us. Let us know how we can help you today.