About Health Savings Accounts
A health savings account (HSA) is a tax-exempt spending account used in conjunction with a high deductible health plan. An HSA is like a 401(k) or IRA, except the HSA is used to save money for qualified medical expenses. Your HSA may be used to pay for medical expenses as they occur, or the funds can remain in your account until you need them later in life.
To open or contribute to an HSA you must be covered by a qualified high deductible health plan (HDHP). An HDHP is an insurance plan with a high deductible dollar amount (or limit) you must satisfy before the plan provides payment. The IRS has certain criteria to qualify an HDHP, your insurance carrier can tell you if your HDHP is HSA eligible. The law prohibits eligibility for an HSA if you are covered by any other health plan that is not an HDHP. However, this provision excludes specific accident, injury, disability, dental, vision, and long-term care insurance, as well as limited purpose flexible spending accounts. In addition to these eligibility requirements, you cannot receive benefits under Medicare or be claimed as a dependent on any other person’s tax return.
HSAs help manage health care costs and can provide you with substantial tax savings. Contributions to medically eligible disbursements from an HSA are not subject to tax. Contributions to an HSA may also be invested in a variety of funds, providing long-term growth potential. In addition, interest and investment earnings on HSA contributions are tax-free.
With an HSA, high deductible health plans are easier to manage. Coinsurance, deductibles, and medical expenses that do not receive first-dollar coverage by your health plan can be reimbursed through an HSA. Aside from medical expenses, an HSA may also cover certain premiums like COBRA and Medicare.
Funds in an HSA roll over from year-to-year. There is no “use it or lose it” rule. For this reason, you do not have to rush medical procedures or purchases at year-end to avoid losing your money. HSAs are individually owned and portable. Unlike similar benefits, your HSA is not forfeited when you terminate or change employment.
Disbursements from the HSA for eligible medical expenses are tax-free but those made for non-qualified expenses are subject to income tax and a 20% penalty. At age 65, or if you become disabled, disbursements for non-qualified expenses may be made without penalty but will still be subject to income tax.
HSAs cover a wide variety of medical, dental, and vision expenses. These expenses must be medically necessary for the diagnosis, treatment, or alleviation of a specific illness or injury. They may include hospital or clinic services, prescription drugs and medications, certain over-the-counter medical supplies, and many other health-related expenses as defined by Section 213(d) of the Internal Revenue Code. Medical expenses covered under the HSA can include expenses that are not covered under the high deductible health plan such as chiropractic, dental, orthodontia, or vision expenses.
HSAs can also be used to pay premiums for COBRA, long-term care insurance, and health plan coverage you may have while receiving unemployment compensation. Once you reach age 65, your HSA can be used to pay Medicare and health insurance premiums, except for Medicare supplemental insurance premiums.
Investing Your HSA Funds
Money contributed to an HSA is deposited into an interest-bearing, FDIC-insured cash account. Once your HSA balance exceeds $2,000, you will have the option to invest your money in a variety of mutual funds. A minimum $2,000 “threshold” or cash balance is required by most plans to invest additional money. If you elect to invest in mutual funds, you will be asked to define your investment threshold. This can be the $2,000 minimum or any greater amount.
If your plan provides a debit card for use with your HSA, it will always be linked to the balance in your cash account. Keep this in mind when deciding the right threshold amount for your HSA. If you swipe your debit card for $100 or more, it will trigger an auto-sweep, meaning money is transferred from the mutual fund investments back to your cash account to replenish the available cash balance. The sale from the mutual funds will be pro-rata by fund balance.
HSAs are individually owned and some responsibilities lie with you, the account holder. You are responsible for ensuring that your contributions do not exceed the established maximum. It is also your responsibility to ensure that your HSA distributions are for qualified expenses. There is no requirement to submit receipts for reimbursement, but you should save receipts in the event of an IRS audit.
You will also be required to file IRS Form 8889 with your income taxes. This form reports your HSA eligibility for the given tax year, as well as your total HSA contributions and distributions for the year. Form 8889 also calculates the tax savings that you have incurred by using an HSA. More information about IRS Form 8889 is available online at irs.gov.
See additional information at HSA Tax Information.