How HSA Health Plans Work

Health Savings Accounts (HSAs) are tax advantaged accounts that can be used to pay for medical care. They can also be used to save for retirement. As with other types of tax deferred accounts, however, an HSA comes with a lot of rules that must be followed. We’ll cover the requirements, rules and regulations in this detailed guide to Health Spending Accounts.

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As healthcare costs in the United States have continued to rise, consumer-driven healthcare plans have become more common. But, with the advent of Obamacare and the subsequent Health Insurance Marketplace, they’ve really taken off.

At its core, consumer-driven healthcare is about putting the power of healthcare spending decisions back into the hands of the consumer. With a consumer-driven plan, you’re often free to shop around between providers to price out various services. This is different from older health plans, where your doctor assigned you to one network specialist, and off you went.

With the growth of the consumer-driven health plan, consumers have more power to make healthcare choices. But they’re typically expected to foot a larger portion of the bill.

This can come as a shock to the financial system for many of us who are used to more traditional $10-copay health insurance plans. This is where the Health Savings Account comes in. This specialized account can help you save for upcoming healthcare expenses while netting tax benefits.

Healthcare Savings Accounts are only available for certain types of health plans, and there are as many contribution and withdrawal rules governing these accounts as there are with tax-advantaged retirement savings plans. Despite their complex nature, though, HSAs can be a great savings vehicle attached to your consumer-driven healthcare plan.

Before you sign up for your company’s HSA or choose an independent healthcare plan that includes one, be sure you understand all the in and outs of this type of account. Here’s what you need to know.

What is an HSA?

An HSA is kind of like a retirement savings account for your healthcare expenses. It’s a tax-preferred account, which means that money you contribute isn’t taxed. Over the course of a year, contributions to an HSA can generate serious tax savings, which we’ll talk about in a minute.

Like other tax-preferred accounts, HSAs come with both withdrawal and contribution limits. The withdrawal limits are fairly straightforward. Money in the account can be used for healthcare-related expenses, including vision and dental care expenses. Each year, the federal government sets contribution limits for individuals and families using HSAs.

How to Qualify

To qualify for an HSA, you must first be signed up for a qualifying health plan. These health plans are known as High Deductible Health Plans (HDHPs). To qualify for an HSA in 2016, your plan must have a minimum individual deductible of $1,300 and a minimum family deductible of $2,600. For most of these plans, this means that you must pay $1,300 out of pocket for one person before your insurance will kick in to cover additional expenses. Many HDHPs have a higher deductible, but this is the minimum to qualify for an HSA.

One other qualification: you can’t be covered by other health plans except what’s allowed in the federal guidelines. Acceptable coverage includes liability coverage like workers’ compensation, coverage for a specific illness or disease, disability insurance, dental care, vision care, or long-term care insurance.

Plus, you cannot use HSA funds if you also have access to a full-fledged flexible spending account (FSA). You can, however, use an HSA in tandem with a limited-use FSA – one that only covers vision and dental care.

Regardless of whether your health plan is employer-sponsored or individual, you qualify for using an HSA provided the plan meets these parameters. Many employers now offer sponsored HSAs, which makes signing up and administrating the account particularly simple. Also, many of the plans on today’s health insurance marketplace include HSAs that are attached to your healthcare plan.

However, you don’t need to have a healthcare plan with an attached HSA in order to own an HSA. As long as your existing healthcare plan meets these parameters, you can open an HSA independently. Many banks and credit unions now offer and administer HSAs. To sign up, you’ll just have to prove that your healthcare plan qualifies.

Choosing an HSA

Even if you’re in an employer-sponsored healthcare plan that comes with an HSA option, you are still free to shop around for an account, just as long as your healthcare plan otherwise qualifies. We’ll talk about using your HSA as an investment in a moment, but know up front that this is a possibility. If your employer’s plan doesn’t offer good HSA investment options, consider taking your funds elsewhere.

Shopping around for an HSA is a wise option, but there are a couple of potential caveats to consider:

  • Employer contributions. Your employer may or may not choose to contribute to an alternative personal HSA. If this is part of your potential benefits package, be sure you don’t lose out on this free money. You can, in fact, open up multiple HSAs. Use the employer-sponsored account to net any employer contributions, but shift your own funds to an independent HSA that offers better investing options. This is fine, so long as the total annual contribution to all accounts is less than or equal to that year’s maximum.
  • Pretax vs. post-tax. With an employer-sponsored HSA, contributions are usually taken from your paycheck pretax. As a result, the savings are realized up front. With an independent HSA, you’ll likely make post-tax contributions, so you won’t see the savings until you file your taxes. This isn’t necessarily a deal-breaker, but is certainly worth consideration.

Where to Open an HSA

If you plan to open an HSA on your own, there are countless options. The key considerations include finding HSAs with a reputable company that offers low fees and good investment options. One of our favorites is Health Savings Administrators.

It offers low cost investment options from Vanguard. It also comes with a debit card tied to the HSA. And its administrative fees are reasonable.

Contributing to an HSA

As with tax-advantaged retirement accounts, HSAs have federally-set limits on annual contributions. These limits typically rise year to year. For 2016, the individual contribution limit is $3,350, and the family limit is $6,750. If you’ll be age 55 or older in 2016, you can make an additional $1,000 contribution to your account.

If you’re using an employer-sponsored HSA, this limit is the combined contributions from you and your employer. In other words, if your employer’s benefits package includes a $2,000 annual contribution to your HSA, you can only contribute $1,350 if you’re on an individual plan and $4,750 if you’re on a family plan.

Speaking of individual vs. family plans, there’s one interesting caveat to HSA contributions. The contribution limit applies based on the people covered by your qualifying HDHP, but the funds can be distributed for any of your dependents.

For example, Mr. and Mrs. Jones are on different employer-sponsored healthcare plans because Mrs. Jones’s employer will only sponsor coverage for herself and their two children. Mrs. Jones’s healthcare plan has a low deductible, so it doesn’t qualify for an HSA.

Mr. Jones, however, is on his own employer-sponsored HDHP. His plan offers an attached HSA, and he wants to contribute. Mr. Jones can only contribute up to the individual limit of $3,350 in 2016. However, he can use the funds he’s contributed to cover healthcare expenses for Mrs. Jones and their children, even though they aren’t covered by his actual healthcare plan.

This can get pretty confusing, and it’s always good to speak with your healthcare administrator to be clear on the rules before signing up for HSA contributions.

Ways to Contribute

How HSA Plans WorkIf you’re on an employer-sponsored healthcare plan with an attached HSA, chances are you can choose to have contributions automatically taken out of your paycheck. These contributions should be taken out of your check before your check is taxed. They’ll save you on your taxes on the front-end by reducing your taxable income. With most employers, you simply have to sign up for per-paycheck or per-year contributions during open enrollment time, or when you’re hired on.

If your employer adds to your HSA as part of your benefits, this should be made clear in healthcare enrollment paperwork. Some employers will “front-load” the account with the full year’s worth of their promised contribution. Others contribute a certain dollar amount per paycheck or per month until they hit the promised contribution. It’s not unusual for employers to use a combination of these approaches, contributing 50% of the total on January 1, and then adding the rest in on a per-paycheck basis.

What if you’re opening an independent HSA or using an independent healthcare plan with an attached HSA? In this case, you’ll have to add after-tax contributions to your account. You can talk with your account administrator about how to do this. Typically, it’s simple to set up recurring transfers to the account so your contributions will be seamless.

The main difference here is that your contributions aren’t saving you taxes up front. Instead, you’ll get paperwork at the end of the year detailing your total contributions, which will then become a tax deduction when you file taxes.

Using Your HSA

Any expense that would qualify for a dental or health care deduction on your taxes qualifies for an HSA distribution. The comprehensive list is found in IRS Publication 502. They include any expenses for the “diagnosis, cure, mitigation, treatment, or prevention of disease” and include prescription medications.

Clearly, the qualified expenses are pretty broad. If you have questions about a specific expense, it’s worth your time to contact your healthcare plan administrator.

Many HSAs come with specialized debit cards that you can use for medical expenses. Often, these limited-use debit cards will reject any transactions that are clearly non-medical. But, you still may be required to provide receipts to the account administrator and, later, the IRS proving that any HSA distributions were for expressly medical expenses.

Other HSAs work on a reimbursement model. In other words, you’ll pay for the expense out of pocket and then send your receipts to the HSA administrator. The administrator will verify the expense and send you a reimbursement by check or direct deposit to your bank account.

If you have the option, the first option is typically easier on your budget. With the reimbursement model, you’re paying into the HSA, ideally, month by month. So your taxable income is already reduced. Then, you have to pay out of pocket for the medical expense, and wait–sometimes a month or more–for your reimbursement to come in. You’ll still reap the tax benefits, but this model can be tough if you’re on a tight budget.

Investing with Your HSA

Depending on where your HSA is set up, you can likely invest the funds into mutual funds or other investments. Like a 401(k), interest is tax-free, as long as your distributions are made appropriately. In the case of an HSA, you’ll avoid tax penalties as long as all withdrawals are for qualified healthcare expenses.

Investing with your HSA is similar to investing with a retirement account, though options may be more limited at this time. Also, according to Betterment, HSA investing costs aren’t as regulated as costs for 401(k)s, so be sure you get a full schedule of fees and charges before you sign up.

Also, check out different HSA providers’ investing options. Some offer full-featured mutual fund options. Others may only offer an account like a typical savings account, which will bear very little interest. You’ll also want to take charge of investing your HSA funds to be sure you’re getting the most bang for your buck.

In some cases, an HSA can be a great additional savings vehicle for retirement. If you find yourself with extra money to save and generally low healthcare expenses, add your HSA to your overall savings strategy. Roll funds over from year to year, and make wise investing decisions. By the time you get to retirement, and likely to the point in your life where your medical care costs are rising, you could have a nice nest egg saved for those specific expenses.

Determining HSA Contributions

One of the best benefits of HSAs (as opposed to their cousins, Flexible Spending Accounts) is that their contents roll over from year to year. There’s no limit to the HSA’s balance, so you can continue saving the maximum each year – even if you have minimal healthcare expenses.

However, you may not want to contribute the maximum annually. If, for instance, you’re prioritizing paying off debt, you may want to make a more conservative contribution to free up funds for debt payments. Depending on your health circumstances, you may also want to prioritize other ways of saving, such as retirement accounts.

You’ll want to carefully consider how much you’re likely to spend on healthcare expenses in a given year when setting your annual contribution. This is less important if you’re making after-tax contributions to an HSA. If you have a major health event during the year, you can always put more money into the account in order to net tax savings before paying your healthcare expenses.

Since you can roll over HSA funds from year to year, it’s not a problem to contribute more than you’ll spend that year. But many employer-sponsored plans only allow you to change per-paycheck contributions during open enrollment. So it’s best to try to hit the right contribution level for you annually.

Look through last year’s healthcare expenses to start. Be sure to account for any changes in your health plan this year, such as higher deductibles or out-of-pocket maximums. Then, think about any additional expenses you’d expect in the coming year. For instance, if you’re trying to add a baby to the family, you might want to consider maxing out the account for a year!

Be thoughtful about your contributions, but don’t stress about it too much. Additional contributions could be invested, earning interest that you can use for future health expenses.

Final Thoughts

Health Savings Accounts aren’t for everyone, and they don’t fit with every healthcare plan. But if your healthcare plan offers an HSA, it’s a great option for saving money on taxes, or even as an additional retirement savings vehicle.

Next Steps

  1. Compare health insurance plans if you don’t have a plan through your employer
  2. Learn more about how an HSA can increase your retirement savings
  3. Check out more ways to save on taxes with retirement accounts

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4 Responses to “How HSA Health Plans Work”

  1. Hi, I think you forgot to mention that there is also a Maximum Out of Pocket limit to opening an HSA…which for 2016 will be 6550. If your OOP is More than that, you can’t open an HSA.
    Also, if your plan somehow actually pays out a little bit for any bill that you incur for medical services, that makes you ineligible for an HSA.
    And then comes the “Last Month Rule” and the “Testing Period.” They say that if you are
    eligible on the “first day of the last month of the tax year”…usually Dec 1st of any given year, then
    you are “eligible, or considered to be eligible” for the entire year. And THEN, you must remain
    eligible right through the whole next year too.
    I’m not sure what happens if you do NOT remain eligible through the entire next year. I think then you have to use that “Limitation Chart” to see how much of your HSA has to be taken out and added in to your yearly income.
    It is pretty confusing.
    I DID open an HSA in 2015 separate from my health plan, even though my health plan did SEEM to be a HDHP…some how they paid a little bit of a bill, even though the plan documents said that I “must pay all costs up to the deductible before this plan begins to pay for covered services you use.” I did not understand WHY they chipped in a little for a bill. I still don’t.
    In any case, I undid my HSA so I wouldn’t get into who knows what sort of trouble.

    And I want to thank you for clearing up a question that even the IRS didn’t really answer for me. Really…I called them. The question was: Can I open up an HSA even if the insurance company that I got my plan from says that they “Don’t participate in HSA’s…HSA’s make the plans too complicated and confusing.” That is what they finally told me. It took a month and a half to get that answer…no one could tell me why a plan was not designated as being able to have an HSA…(the ins. co. couldn’t tell me, and the NYS of Health website people couldn’t tell me…the NYS of Health website didn’t even know what an HSA was…) Unbelievable.
    From what you said here, a person CAN open an HSA even if the insurance company does not participate. Good. Maybe I will try again later on to open one…Thanks for this article.

  2. Rosette-Andree

    Dear Ms. Hayes,

    What a great article and you are a) very detailed, and b) articulate and clear. Just a joy to read, thank you! Picked up your piece through DoughRoller! I have enjoyed previous articles from you.

    If I were to elect an HSA, independently, on my own, is a minimum deductible of $1,300 obligatory, part and parcel of the plan? And if it’s a minimum, what’s the possible maximum? So, while the contributions are after-tax, they are deductible at the end of the year, so that’s good. I will need to get with my accountant to know whether I will need to itemize to benefit from this deductible. I do not itemize, can’t reach the minimum in order to qualify.

    Thank you for your time, Ms. Hayes,
    Rosette-Andree

  3. Is it true that when you turn 65 and have to register for Medicare hospital coverage that you can no longer contribute to your HSA? A friend of mine read this on the Internet somewhere, and I have not been able to confrm this. Contacting the Medicare department seems impossible

    • Stephanie Colestock
      Stephanie Colestock

      Louise,

      If you’re enrolled in Medicare, you can no longer contribute to an HSA, according to the IRS (https://www.irs.gov/publications/p969/index.html). You can continue to withdraw what’s in the account, but you can no longer add funds.

      Say you plan to work past 65 and want to keep contributing to an HSA? You can work around the rules.

      Just because you’re eligible for Medicare doesn’t mean you HAVE to enroll… you can continue working and keep on utilizing your HSA in the meantime. The caveat is that you cannot have applied for either Medicare OR Social Security retirement benefits.

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