You may have heard of the term HSA before but aren’t sure what it really means and if you should be using one.  A health savings account (HSA) is essentially a savings account for medical expenses.  These accounts are available to anyone who is employed, self-employed, or even unemployed (think stay at home parent or college student).  To qualify to use an HSA, you must meet a few requirements.  First, you must be enrolled in a high deductible health plan (HDHP) which is available through an employer or through the Marketplace.  Until the time the deductible is met, this type of plan will only cover preventative services. Second, the HDHP must be your only form of health insurance coverage.  Third, you must be under the age of 65 and not eligible for Medicare.  Last, you cannot be claimed as a dependent on someone else’s taxes.  This also means you cannot set-up and contribute to an HSA for your children or grandchildren.

Contributions to an HSA are made on a pre-tax basis, which means they are deductible and reduce your taxable income.  Contributions can be made through payroll deductions, direct contributions by you, or employer contributions on your behalf.  If your HDHP only covers yourself, you can contribute up to $3,500 in 2019 and if the plan covers you and your family, you can contribute up to $7,000.  Keep in mind the contributions employers make on behalf of the employee count towards the annual limit.  The annual contribution limit is set for inflation and is not limited by income.  Moreover, if you are 55 or older, you can make an additional “catch-up” contribution of $1,000 but your total family annual contribution cannot exceed $9,000. 

Many financial institutions offer HSAs and the accounts can earn interest or can be invested in mutual funds.   As an added benefit, these earnings are tax-free if withdrawn for qualified medical expenses.

Distributions from the HSA account must be used to pay for qualified medical expenses.  These include deductibles, copayments, coinsurance, and many other medical expenses such as prescriptions and vision or dental care.  You can consult IRS Publication 969 to see a full list of qualified expenses.  However, HSA funds cannot be used to pay the premiums for your HDHP.  Distributions which are not used for qualified medical expenses must be added to taxable income on your tax return and will be subject to a whopping 20% penalty!  Generally, you will receive either checks or a debit card for the HSA account that you can use to pay for medical expenses.  For example, if you see your doctor and have a co-pay of $25, you can use the HSA debit card to pay.  Alternatively, you can choose to pay with your personal funds and turn in the receipt to your HSA administrator to receive reimbursement.

One great benefit of an HSA account is the funds never expire, and they essentially rollover from year to year.  This is different from a Flexible Spending Account in which funds not used by the end of the year will be forfeited.  An HSA account is entirely yours and it goes where you go and it can be moved to a different HSA account without penalty.  What happens if you start contributing to an HSA account before retirement and have funds saved up after you retire?  Since there are no expiration dates on HSA funds, they can be used for qualified medical expenses incurred after age 65 as a tax-free and penalty-free distribution.  Also, medicare premiums become a qualified medical expense.  Funds could also be withdrawn for nonqualified expenses and be subject to only your income tax rate as the penalty is abated after age 65.  As such, unused HSA funds act exactly like another IRA account. However, remember you can no longer contribute funds to an HSA after age 65 if you are covered under Medicare.  An HSA can also be used as a type of retirement account.  You can contribute into the HSA every year you are eligible and keep the receipts of qualified medical expenses you incur during those years and not turn them into the HSA administrator.  During this time the account can grow tax-free.  Then after retirement you can turn in all your receipts that were kept throughout the years and get reimbursed at that time.  You are not required to turn in the receipts in the year you incur them. 

If you find yourself in the position of enrolling in a HDHP, consider opening an HSA account as it is a tax-free way to pay for the medical expenses that occur with a HDHP. However, be sure you are meeting the requirements of an HSA account so contributions aren’t disqualified.  If you have questions, don’t hesitate to contact your KT Advisor.