The Tax Breaks of Health Savings Accounts (HSAs)

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Health Savings Accounts (HSAs) were created by the Medicare bill signed by President Bush on December 8, 2003. HSAs are tax advantaged medical savings accounts which enable adults to pay for their current health expenses and save for future medical and retiree health expenses on a tax-free basis.

Such accounts are available to taxpayers in the United States who are enrolled in a High Deductible Health Plan (HDHP). An HDHP, based on 2010 guidelines, is considered any health plan where the minimum deductible is $1,200 for individuals and $2,400 for families. The amount contributed to an HSA belongs to the account owner and is portable. The account owner, similar to an IRA, is able to decide what types of investments should be made in the HSA account. Funds grow tax free in the account and can be used to pay for qualified medical expenses at any time without federal tax liability or penalty.

However, once an individual enrolls in Medicare they are no longer eligible to contribute to their HSA. In 2010, the U.S. Treasury and the IRS issued new guidelines for maximum contributions to HSAs: individuals may contribute an annual maximum of $3,050, and families, covering two or more individuals, may contribute up to $6,150.  In addition to normal contributions, individuals 55 and older can make “catch-up” contributions.  In 2010, catch up contributions were set at $1,000 for individuals who age 55 or older who were not on Medicare.

Unlike a flexible spending account (FSA) in which funds are forfeited if not used by year end, funds in an HSA roll over and accumulate year to year if not spent.  Withdrawals for non-medical expenses from an HSA are treated very similarly to those in an IRA, in that they incur a 10% penalty if taken before retirement age.  If money is withdrawn after age 65 for non-qualified medical expenses, the account owner pays only income tax on the amount withdrawn.

In summary, an HSA offers participants the following benefits:

  • Money deposited is 100% tax-deductible, and money in the account grows tax-deferred
  • For early retirees who are healthy, an HSA can help lower health insurance costs before Medicare kicks in
  • You are able to make withdrawals tax-free to pay for medical expenses anytime before or after age 65
  • You can make catch up contributions if you are 55 or older; such contributions are indexed to the Consumer Price Index (CPI), so they will increase at the rate of inflation each year
  • There are numerous banks that can act as HSA administrator; some offer only savings accounts, while others offer mutual funds or access to a full-service brokerage
  • Although contributions to HSAs must cease when Medicare kicks in, individuals can use the money in their HSA account to pay Medicare premiums, deductibles, copays, and coinsurance. Additionally, there may be expenses that Medicare will not cover but that you can pay for from your HSA

Proponents of HSAs believe they are fundamental to reforming the health care system because they encourage savings for future health care expenses, allow individuals to decide how to spend their funds on medical care and make them more responsible for their own health care choices through the required HDHP.  Opponents on the other hand, say they make the health care system more inefficient because people who are healthy will leave insurance plans while people who have health problems will avoid HSAs.  Additionally, some believe medical expenses should be tax deductible regardless of whether one opens a HSA.

In terms of health care reform, HSAs  have pros and cons but they certainly serve as a supplement to ones retirement savings.  Over time, if medical expenses are low and contributions are made to the HSA on a consistent basis, the account can grow significantly and funds can be used for tax free health care or for retirement on a tax-deferred basis.

Published or Updated: February 16, 2013
About Rob Berger

Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.

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