The Benefits of Health Savings Accounts

Didn’t think there was a way to take money out of your IRA without having to pay a penalty? In this article I’ll tell you how to do that and give you more great reasons to love a Health Savings Account.

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What is a Health Savings Account?

You may have heard of a Health Savings Account (HSA), but if you’re like many people, you may not know much about them. I wrote post number 84 on Health Savings Accounts about a year and a half ago—but I’m such a big fan of the HSA that I thought it was time to revisit the topic.

Health Savings Accounts were created in 2003 to help you save for future medical expenses on a tax-free basis. That means you don’t have to pay taxes on the money you contribute to an HSA—you get to deduct the amounts from your taxable income when you file your income tax return. And less taxable income is always a good thing because it results in a lower tax liability!

You contribute money to an HSA and then you spend the money on medical expenses that aren’t covered by your health insurance, such as your health insurance deductible, dental bills, vision expenses, and over-the-counter medicines. You own the account as an individual, control it completely, and don’t have to itemize deductions on your income tax return to take advantage of it. Also, there are no minimum or maximum income limits you have to meet to be eligible to contribute to an HSA.

It’s important to note that an HSA only works in conjunction with a certain kind of health insurance policy called a high deductible health plan (HDHP). So in order to be qualified to open up an HSA, you have to be enrolled in a high deductible health plan first.

What is a High Deductible Heath Plan?

Before we get into more details about HSAs, let’s discuss what makes a health policy a high deductible plan in the first place. A high deductible health plan is simply a heath insurance policy that has a high deductible. A deductible is the amount you have to pay out-of-pocket before your insurance kicks in and starts to pay expenses for you. The higher the deductible, the lower your monthly insurance premiums will be. That can make high deductible plans more affordable, depending on your health needs.

Many employers are moving from traditional health policies to high deductible plans to cut their costs. So it’s possible that you might have a high-deductible plan, but not be fully aware of the HSA benefits that go along with it. Here are the requirements for a health insurance policy to be considered a high deductible plan for 2010:

• The annual deductible must be at least $1,200 for an individual policy or $2,400 for a family policy.

• The annual cap for out-of-pocket expenses can’t exceed $5,950 for an individual policy or $11,900 for a family policy.

You qualify for an HSA whether you pay for a high deductible plan on your own or through work.

How Much Can You Contribute to an Health Savings Account?

The annual contribution you can make to a Health Savings Account in 2010 is up to $3,050 for an individual policy or up to $6,150 for a family policy. Contributions can be made up to April 15th following the tax year. So to make contributions for 2010, you have until April 15th of 2011. If you’re 55 or older, you can save an additional $1,000 per year whether you have an individual or family plan. These amounts are indexed annually for inflation, so check hsacenter.com for up-to-date information in future years.

Your eligibility to contribute to an HSA starts as soon as your high deductible health plan coverage begins. As long as you’re covered by December 1st, you’re eligible to contribute the maximum amount for the tax year. However, any medical expenses that you incur before the date you establish your HSA can’t be reimbursed from the account.

How to Fund an HSA with an IRA

You may be thinking that having an HSA sounds great, but where would you get the extra money to fund it? That brings me to one of the HSA’s best features: You can make a once-in-a-lifetime transfer from your IRA to fund an HSA without paying an early withdrawal penalty! That’s how I opened my HSA years ago and I’ve never regretted it.

What Happens To Unused HSA Funds?

After you fund an HSA, what happens to the money if you don’t spend it? The answer is, absolutely nothing. That’s right; your HSA balance simply rolls over from year to year. There’s no time limit to spend the money, nor do you have to spend a dime from your HSA if you don’t want to. Even if you cancel your high deductible health plan, you can still use the money in your HSA indefinitely to pay for medical expenses tax-free. However, you won’t be eligible to contribute additional money to an HSA if you’re not insured by a high deductible plan.

If you still have funds in an HSA after you turn 65 it morphs into something very similar to a retirement account. You can use the money for non-medical expenses without penalty (but you still have to pay ordinary income tax on those amounts). Be aware that if you’re under the age of 65 and use HSA funds for anything other than qualified medical expenses you have to pay income tax plus a 10% penalty on the amount.

In a few weeks, I’ll give you even more reasons to love an HSA, and explain how it will be affected by healthcare reform. I’ll tell you exactly how to set one up and how I manage mine. You’ll discover the surprising variety of products and services that are considered qualified medical expenses—like my fancy new prescription sunglasses!

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More Resources:
HSAcenter.com
HSA Information from the U.S. Department of the Treasury
IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans

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