With health costs rising, and with frustration over ever-higher health insurance premiums, it is little surprise that many are looking for alternatives to the types of health insurance plans we are used to. In an effort to provide more options for paying for health care, the Health Savings Account was signed into law in 2003 as part of the Medicare Prescription Drug, Improvement, and Modernization Act. It provides a way for consumers to set aside money for medical expenses, and provides a way for that money to grow tax free in an account that bears a striking resemblance to an IRA.
How a Health Savings Account Works
In order to open a Health Savings Account (HSA), you have to have a high-deductible health plan. This can be a plan through your employer, or a plan that you get on an individual basis. HSAs can be augmented with money from an employer, but it is important to note that you own your account, no matter who is contributing to it. All deposits in the account automatically become your property. Additionally, money rolls over year-to-year. This is an important distinction, since Flexible Spending Accounts (sometimes called cafeteria plans) are use-it-or-lose-it accounts that do not roll over. When you have a HSA, that money continues to grow.
Once it is established that you have a high-deductible health plan, and you open a HSA, you can begin contributing. There are contribution limits amounting to $3,050 for individuals and $6,150 for families in 2010. These limits are not subject to income. If you are over 55, you can make an additional “catch up” contribution of $1,000. This money is invested as you direct within the account. The money you contribute to a HSA grows, and yields a return, helping your account grow faster. You can withdraw money from the account to pay for qualified medical expenses, including dental, eye care, some health care products, co-pays, deductibles, specialist visits, prescriptions and more. (Note that starting in 2011, over the counter medication will no longer be considered a “qualified” expense.) As long as the money is used for qualified medical expenses — save your receipts — you will not be taxed on the earnings in your account.
The way you withdraw money from your HSA depends on the company administering the account. Check to see whether your account is accessed by debit card, specially issued checks, or a reimbursement process. You can actually withdraw money from a HSA for any purpose — even if it is not for health care expenses. However, you will incur a 10% penalty if you do not use the money for medical expenses. On top of that, the withdrawal is taxed as income if not used for health care expenses. Once you reach the age of 65, though, or are disabled, you can withdraw the money from your HSA for any reason without paying the 10% penalty. However, any non-medical withdrawals will be taxed as income (your withdrawals for health care expenses continue to be tax free).
You cannot roll your HSA into a 401k or IRA. You can do a one-time transfer of an IRA into a HSA, but that is all the rollover that is allowed. Make sure that you speak with a trusted financial professional or tax professional to learn the implications of this one-time rollover before you begin the process. In an HSA with money contributed through your employer, the money comes out pre-tax, lowering your adjusted gross income. If you do not have an employer, you contribute money with post-tax dollars, but you can then take an above the line deduction to lower your gross income on the front of your Form 1040.
Using Your HSA
In many cases, the HSA is of the greatest benefit if you are relatively healthy, and do not make a lot of trips to the doctor each year. You can save money by increasing your deductible and co-pays, so that you pay more out of pocket for your expenses, but your premiums are lower. On top of that, you can use the money from the HSA to cover your deductible, so if you save up enough before you have a major expense, it is possible to cover your higher deductible with relative ease. And, since you are putting money into a HSA that grows on your behalf through investments, you aren’t just sending that money to an insurance company. It benefits you, since you will have access to that money in later years if a medical catastrophe doesn’t wipe the account out. With insurance, if you never need the big payout, that money is lost to you. With a HSA, the money you put in is always yours, and you can withdraw it to help your cash flow later on.