This is page three of a Health Savings Account Handbook guide. Start with page one to understand all of the ins and outs of Health Savings Accounts (HSAs).
Contents
- Overview
- What is an HSA?
- How do Health Savings Accounts (HSAs) stack up against Individual Retirement Accounts (IRAs) or 401(k) plans?
- Should you consider a Health Savings Account (HSA)?
- Legal considerations
- Healthcare reform
- Summary
Overview
A Health Savings Account (HSA) is defined by the government as a “tax-exempt trust or custodial account you set up with a qualified HSA trustee [for example, a bank, insurance company, or Treasury-approved non-bank custodian or trustee] to pay or reimburse certain medical expenses you incur.”
Many HSA administrators offer online banking services similar to those for personal bank accounts, often federally insured—refer to your custodian or trustee’s literature for confirmation.
HSA holders can potentially increase their earnings by investing in qualified investment accounts such as stocks and mutual funds, though these investments may not be guaranteed or insured by the government.
Like other health plans, an HSA-qualified health plan (also known as a high-deductible or consumer choice health plan) safeguards against catastrophic medical costs from serious illnesses, severe injuries, hospitalizations, or chronic diseases.
If you qualify, both you and your employer can make tax-advantaged contributions to your HSA, with funds being used tax-free in most situations to cover various qualified medical expenses.
Any excess contributions that remain unused in your HSA can accumulate and grow over time, especially if you choose to invest them. By strategically using an HSA alongside an HSA-qualified health plan, a 401(k), and other retirement accounts, you can prepare for both future healthcare needs and retirement.
For details on who can open or contribute to an HSA, please refer to the “Who can establish and contribute to an HSA?” section of Page 4 or Page 5. For guidance on saving and investing HSA funds, see Page 7.
What is an HSA?
A Health Savings Account (HSA) is an account where you can deposit money to cover qualified out-of-pocket healthcare expenses. Since predicting yearly healthcare costs is difficult, having an HSA helps manage these expenses over time.
When you pay more for coverage than your health plan needs to cover your medical expenses, you don’t financially benefit, and there’s no refund for unused premium payments. Usually, if you’re employed, your employer covers more than half of your premiums.
HSA-qualified health plans typically have lower premiums than traditional plans. The difference between what you contribute to your HSA and what you spend annually can be saved for future healthcare expenses. Additionally, you save money by not paying taxes on your HSA contributions.
With an HSA-qualified health plan, you have more flexibility and control over your HSA funds. Since you own your HSA, any savings from spending less than you contribute in a year stay with you.
In summary, HSA funds can be used for qualified medical expenses, and any unspent funds remain yours. You and your employer can make tax-advantaged contributions to your HSA if you have HSA-qualified coverage and no impermissible healthcare coverage. Refer to the previous page for HSA-qualified health plan requirements.
You can use HSA funds tax-free to cover the following qualified expenses:
- Your insurance deductible
- Copayments and coinsurance that you need to pay before reaching your health plan’s out-of-pocket maximum. (Your HSA-qualified health plan covers the rest.)
- Qualified prescription, medical, vision, or dental expenses
- Other qualified medical expenses that insurance plans might exclude
Tax advantages
An HSA offers potential triple-tax savings because you don’t pay taxes on your contributions, earnings, or distributions if you adhere to the rules.
The triple-tax advantage entails:
- No federal tax on contributions to your HSA, whether they come from you, your employer, or family and friends. Additionally, unlike a 401(k), you’re exempt from paying Social Security (FICA) and Medicare taxes on the contributions made by you and your employer through payroll. Moreover, in most states, you’re not liable to pay state tax on contributions to your HSA. However, it’s advisable to consult your tax advisor for information on states that may not exempt HSA contributions from taxation.
- Your account and investment earnings grow tax-free as long as you use the money for qualified medical expenses.
- No taxes on funds distributed from your HSA if you use the money for qualified medical expenses.
Contributing funds to your HSA on a pre-tax basis not only lowers your income tax liability but may also decrease other employment-related taxes, including the following:
By contributing to your HSA using pre-tax payroll deductions (instead of making deposits outside of payroll or accepting contributions from others), you not only lower your taxable income but also potentially reduce other employment-related taxes, including the following:
Federal Insurance Contributions Act (FICA) taxes, which include:
- Social Security tax: 6.2%
- Medicare tax: 1.45%
- Medicare surtax: 0.9% for earners over $200,000
Your employer withholds FICA taxes from each paycheck you receive. Additionally, your employer pays their share of Social Security and Medicare taxes based on your earnings, but these taxes do not come out of your paycheck.
Federal Unemployment Tax Act (FUTA) taxes are paid by your employer on the first $7,000 you earn, but this amount is not withheld from your wages. When you or your employer contribute to your HSA, it reduces the total earnings used to calculate the FUTA tax. (Refer to Chapter 1 for more details.)
State Unemployment Tax Act (SUTA) is the state counterpart of FUTA. Each state establishes its own unemployment tax rate and wage base. When you or your employer contribute to your HSA pre-tax, it reduces the earnings used to calculate the employer-paid SUTA tax in most states.
Who owns your HSA?
You own all the money in your HSA, including contributions from your employer, regardless of changes in your job status, health plan, or retirement. Unlike certain Flexible Spending Arrangements (FSAs) or Health Reimbursement Arrangements (HRAs) that may be forfeited upon termination of employment or at the end of a plan year, you cannot lose or forfeit your HSA funds.
However, the government imposes limits on how much you can contribute to your HSA each year to qualify for the unique tax advantages it offers. If you contribute more than the federally mandated limits, you will incur income tax on the excess amount, along with a penalty. For more details on HSA contributions, refer to Page 5.
HSA Contribution Limit
| Year | Individual | Family | Catch-up (over 55) |
|---|---|---|---|
| 2021 | $3,600 | $7,200 | $1,000 |
| 2022 | $3,650 | $7,300 | $1,000 |
| 2023 | $3,850 | $7,750 | $1,000 |
| 2024 | $4,150 | $8,300 | $1,000 |
As your balance rolls over from year to year, it grows in value, accruing interest and potentially increasing through investments, much like an IRA or a 401(k). Once your balance reaches a certain threshold, many HSA administrators permit you to invest the funds tax-free, similar to how you invest dollars from other retirement accounts. You can inquire with your custodian about available investment options and any minimum requirements. For further details on saving and investing HSA funds, refer to Page 7.
Choice and flexibility
An HSA-qualified health plan offers flexibility in managing your healthcare choices. You have full control over how you utilize the funds in your HSA, whether you opt to save them for future expenses or use them for current healthcare needs.
Pay for qualified medical expenses
You can utilize your HSA to reimburse qualified out-of-pocket healthcare expenses not covered by your health plan, including those you could deduct on your federal tax returns. Additionally, you can use HSA funds for certain items, like specific over-the-counter medications and menstrual products, that aren’t deductible on your taxes.
However, it’s important not to use your HSA for expenses you plan to deduct on your tax return or for which you’re already reimbursed by your health plan or another source.
(IRS Publications 969 and 502, when used together, provide guidance about qualified expenses)
Cover work/life transitions
You can utilize an HSA to cover qualified medical expenses or health plan premiums even while you’re receiving unemployment compensation. Additionally, you can use it for COBRA (Consolidated Omnibus Budget Reconciliation Act) premiums, which provide continued healthcare coverage through your former employer, or for certain premiums related to long-term care.
Pay for healthcare expenses after retirement
HSAs serve as a tool to save for healthcare expenses during retirement, offering tax-free benefits. You can utilize your HSA funds to cover various qualified out-of-pocket expenses, such as deductibles, copays, coinsurance, and certain Medicare premiums.
These premiums include those for Medicare Part A (hospital and inpatient services), Part B (physician and outpatient services), Part C (Medicare Advantage plans), and Part D (prescription drugs). However, it’s important to note that Medigap or Medicare supplements are not covered by HSA funds.
Manage the variability of expenses
Health Savings Accounts (HSAs) offer a practical solution for handling the fluctuations in healthcare expenses.
In one year, you might encounter minimal healthcare costs, whereas the following year could see you reaching your deductible halfway through and facing additional expenses.
With an HSA, you have the flexibility to decide when to reimburse yourself, enabling you to save your funds for periods of higher expenses. It’s essential to remember that HSA funds can only be utilized for qualified expenses that arise after you establish your HSA.
Benefit from a healthy lifestyle
Starting in 2011, special health plans called HSA-qualified plans have to cover certain preventative care services for free, without you having to pay anything extra. These services help catch health problems early or prevent them from happening in the first place.
When you make use of these preventative care services and also practice healthy habits in your daily life, like eating well and staying active, you might end up needing less medical care in the future. This means you could save money on healthcare as you get older, which is great for planning for retirement when you might need extra money for other fun things!
How do Health Savings Accounts (HSAs) stack up against Individual Retirement Accounts (IRAs) or 401(k) plans?
HSAs are kind of like retirement accounts, such as IRAs and 401(k) plans. They share some cool features, like being able to roll over money from year to year, move them from one place to another, choose where to invest your money, and even pass them on to someone else if something happens to you.
People use all sorts of these special accounts, like Roth IRAs, 529 education accounts, and Coverdell accounts, to save up for things like retirement or paying for school. They’re great because they help you save money without having to pay as much in taxes.
Commonalities between a Health Savings Account (HSA) and retirement accounts such as a 401(k) or IRA.
- You and your employer can both add money to your account before taxes are taken out. However, while employers can contribute to a 401(k) above what individuals contribute, the total contributions from both you and your employer to your HSA cannot exceed the set limit.
- Any money you don’t spend in your account rolls over to the next year and stays there until you need it.
- The money in your account grows without being taxed for as long as you have the account.
- When you pass away, your account becomes part of your estate, meaning your survivors can inherit the money. If your spouse inherits it, they can treat it as their own HSA without paying taxes on it.
Benefits of a Health Savings Account (HSA)
- Neither you nor your employer pay Social Security and Medicare taxes on HSA contributions made through payroll.
- You can contribute money from both earned and unearned income up to the IRS annual limit if you have HSA-qualified health coverage and no other disqualifying coverage. Family members can contribute too, but only you and your employer receive the tax benefits. Remember, your tax benefits are limited to your taxable income, and you can’t carry your deduction forward to another year.
- You can use HSA funds to pay for qualified medical expenses for your spouse and IRS-qualified dependents tax-free.
- Even if you’re not employed anymore, you can still make tax-advantaged contributions to your HSA as long as you’re covered by an HSA-qualified plan and not enrolled in Medicare or have any other disqualifying coverage.
- If you use the funds for qualified medical expenses, you can make tax-free distributions at any time without penalty.
- Once you turn 65, you can use HSA distributions for anything without paying a 20% penalty. However, you’ll need to pay income tax on distributions not used for qualified medical expenses.
Should you consider a Health Savings Account (HSA)?
Having an HSA gives you peace of mind because you have money saved up for medical expenses, whether they’re planned or unexpected. It helps you make smart choices about how to spend your healthcare money and lets you budget better. To get the most out of your HSA, check if you’re eligible to open one, contribute money to it, or use the money for medical expenses.
If you can’t contribute through your job, see if you can claim a tax deduction. Before picking an HSA-qualified health plan, think about your family’s health needs and how often you might change jobs or health plans. For examples that compare costs, check out the “Examples” section in “Saving and investing HSA funds.”
Spending retirement funds without incurring taxes
Even though laws like the Affordable Care Act and changes to Medicare have tried to help, healthcare costs keep going up. Experts say many retired people won’t have enough money saved to cover all their medical expenses as they get older.
One study by the Employee Benefit Research Institute found that the average 65-year-old couple needs around $296,000 saved up to pay for medical costs during retirement, including things like Medicare premiums, deductibles, and prescription drugs. If they have higher prescription costs, they might need about $361,000.
Lots of retirees use money from their 401(k) or other retirement savings to pay for medical bills. But the problem is, they have to pay taxes on that money.
Using money from an HSA can help retirees save a lot on taxes because they can use it to pay for medical expenses without being taxed. This means they can make their retirement savings last longer, whether it’s in an IRA, Roth IRA, or 401(k)/403(b).
Chronic conditions
When you’re picking a health plan, whether it’s from your job or you’re choosing one yourself, think about how you’ve used healthcare before.
If you or someone in your family has a long-lasting or recurring health issue that needs treatment but can’t be cured, like diabetes or asthma, an HSA might be a good choice. Some HSA plans count certain medications for these conditions as preventive care, so they’re covered even before you pay your deductible.
Not all chronic conditions need expensive treatment. Some just need regular check-ups, following a treatment plan, or using special medical devices. You can use money from your HSA to pay for these things.
Before you decide on an HSA plan, compare it with other plans that have lower deductibles and higher premiums. Think about which one works best for you.
As costs for premiums, copays, and coinsurance keep going up, HSA plans could save you money in the long run.
Unexpected costs
Even if you and your family are healthy, having healthcare coverage is important in case something unexpected happens or you get really sick.
Some people don’t spend much on healthcare each year, so they never reach their deductibles. An HSA plan is good for these people because they can save money tax-free for years when they need more healthcare.
Think about if you can save money regularly in an HSA to cover your usual healthcare needs, like medicine, doctor visits, and treatment for small health problems.
Job changes
Think about your job, what industry you work in, and what kind of work you do. Some jobs change more often than others, especially for younger people who might switch jobs more frequently.
If you have a COBRA-qualifying event, like losing your job, you can keep your HSA-qualified health plan. You can also use your HSA to pay for COBRA premiums and healthcare costs when you don’t have other coverage. This can be really helpful during tough times, like when the economy isn’t doing well.
When you’re looking at the benefits your new employer offers, make sure to check if they have any HSA-qualified plans so you can keep adding money to your HSA.
Legal considerations
Since HSAs were created in 2004, different laws have shaped and defined how they work.
In December 2003, President George W. Bush signed a law called the Medicare Prescription Drug Improvement and Modernization Act of 2003. This law added a new section to the tax code, allowing people to start HSAs in 2004.
In March 2010, President Obama signed the Patient Protection and Affordable Care Act (PPACA), which made changes to many healthcare rules, including some that affect HSAs.
In March 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). This law lets people use their HSA to pay for over-the-counter medications and menstrual products.
These laws set the rules for how HSAs work.
Trusts and HSAs
HSAs are treated like trusts under the law because individual account holders own them, and specific rules govern them. Both state and federal laws affect how HSAs work.
Trusts involve a fiduciary relationship, meaning a bank, corporation, or other entity acts as a trustee, holding legal title and using the trust for the benefit of the owner.
Trustees have a legal responsibility to manage and invest funds for the benefit of another person or entity. Custodians, on the other hand, simply maintain accounts without investment responsibilities. Only banks, insurance companies, and certain non-bank entities qualify as HSA trustees.
The trustee must handle the trust property honestly, prioritize the beneficiary’s interests, and follow the terms of the trust closely. While trustees may have some discretion over investments and management, the trust agreement still guides these actions. The trustee administers an HSA to pay for qualified medical expenses.
Opening a trust
In many states, depositing funds into the HSA is seen as opening the account. This date matters because it affects how much you can contribute in the first year and which expenses you can pay from the account.
Different states may have their own rules about setting up trusts. For example, Utah changed its trust law in 2009 to allow the HSA to start when the account holder joins an HSA-qualified health plan, as long as it’s before the tax return filing deadline.
These dates decide when you can start paying for expenses using your HSA.
Health Savings Account-eligible health plans: Differences between federal and state regulations
State laws can affect how HSAs are taxed. Sometimes, a plan might follow federal rules but not meet state standards. If state insurance laws clash with federal HSA laws, you might not be allowed to join an HSA plan, or you might need special permission.
Many states have their own insurance laws that might not match federal laws. For example, some states require health plans to cover certain medical services (like preventive care) before you’ve paid your deductible. This could affect the tax status of your HSA because it’s supposed to cover expenses after meeting the deductible. To solve this, many state laws exempt HSA plans from these requirements so they can cover preventive care without needing to meet the deductible.
While federal taxes don’t apply to HSA contributions, earnings, or withdrawals for medical expenses, state taxes might treat them differently. This also applies to local income taxes, the state taxes that fund unemployment benefits, and estate laws. It’s best to talk to a tax expert to understand your specific tax situation.
Healthcare reform
When President Obama signed the PPACA into law in 2010, some people worried it might hurt HSAs. But, regulations have actually helped clarify things and might even make HSAs more popular. The CARES Act also brought more benefits to HSA owners.
Here are some of the changes from the PPACA and CARES Act:
- Pre-existing condition exclusions were waived.
- Lifetime and annual coverage limits were removed.
- Preventive care is now covered without you having to pay.
- The prescription requirement for over-the-counter medication was eliminated.
Health insurance exchanges
People can get health insurance in different ways: from their job, directly from an insurance company, or through a health insurance exchange. Exchanges like HealthCare.gov let you compare different health plans.
Most states use the federal exchange, but some have their own. These include California, Colorado, and others.
HSA-qualified health plans from these exchanges often cost less. Health reform has helped many people get affordable coverage by giving tax credits and making it easier to sign up. But if your job offers affordable coverage, you might not qualify for subsidies.
Penalties
In 2014, a rule called the PPACA said that if you didn’t buy health insurance, you’d have to pay a fine. This fine got bigger each year until 2017 when Congress got rid of it.
On December 19, 2017, Congress made a new law called the Tax Cut and Jobs Act of 2017. This law got rid of the fine for not having health insurance, starting in 2019 (for taxes filed in 2020). But the law still says that people need to have health insurance, they just won’t get fined if they don’t.
Essential health benefits
Since 2014, health plans that follow the ACA rules have to cover certain important things called “essential health benefits” or EHBs. These include:
- Doctor visits where you don’t stay overnight (ambulatory patient services)
- Emergency trips to the hospital
- Being admitted to the hospital
- Care for moms and newborn babies
- Help for mental health issues and drug problems
- Medicines prescribed by a doctor
- Services and tools to help with getting better after an illness or injury (rehabilitative and habilitative services and devices)
- Tests done in a lab
- Check-ups to keep you healthy and manage diseases
- Healthcare for kids, including dental and eye care
Essential health benefits (EHBs) have specific rules they must follow:
- There are limits to how much you can be asked to pay out of your own pocket each year for in-network care. In 2023, it’s [amount], and in 2024, it’s [amount].
- The plan has to cover at least 60% of the overall cost of care. This is called the actuarial value (AV). It means that if you add up all the costs the plan covers, the plan has to pay for at least 60% of them. The money your employer puts into your HSA counts toward this 60% requirement.
- Besides the limits set by the ACA, HSA-qualified health plans also have to follow extra rules from the IRS. These rules include different minimum deductibles and maximum out-of-pocket limits. You can find more about deductibles in the “Deductibles” section of Chapter 1, “Health coverage terms.”
Preexisting conditions
Insurance companies can’t say no to covering treatment for pre-existing conditions anymore. They also can’t charge you more based on your health, gender, or other things. The only things they can consider when setting premiums are age (with a maximum ratio of 3:1, meaning a 65-year-old can be charged up to three times what a 21-year-old pays), where you live, how big your family is, and if you use tobacco.
Annual and lifetime limits
Starting in 2010, some plans stopped putting limits on the benefits they’d pay each year or over your lifetime. By 2014, all main health plans (except small or limited plans) got rid of these annual limits. This meant you didn’t have to buy extra coverage anymore.
Clinical trials
Since 2014, the PPACA has made it illegal for plans to cancel coverage if someone joins a clinical trial. Plans also can’t refuse coverage for regular care they’d normally provide if someone’s in a clinical trial. This rule covers trials for cancer or other serious diseases.
Summary
A Health Savings Account (HSA) is a way to save money for healthcare costs while enjoying tax benefits. Here’s how it works:
- To qualify, you need an HSA-eligible health plan and no other disqualifying coverage.
- You own the account, and your money can grow over time.
- HSAs offer triple-tax advantages: Contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are tax-free.
- You can use the funds for medical expenses or save them for the future.
- HSAs are managed by trustees or custodians.
- There are yearly contribution limits set by the IRS, and anyone can contribute, but total contributions must stay within the limit.