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Health Savings Accounts (HSA)

Overview

A health savings account is a tax-sheltered savings account similar to the IRA, but earmarked for medical expenses. Deposits are 100% tax-deductible for the self-employed (and now almost everyone with the HSA) and can be easily withdrawn by check or debit card to pay routine medical bills with tax-free dollars.

Larger medical expenses are covered by a low-cost, high deductible health insurance policy. What is not used from the account each year stays in the account and continues to grow interest on a tax-favored basis to supplement retirement, just like an IRA! When combined with a low-cost, high deductible health insurance policy (required), the health savings account is meant to replace a traditional high-cost health insurance policy (with its low co-pays and mountains of restrictions on medical choices). A health savings plan will restore a high degree of freedom of choice by allowing you to choose your own physician (typically from an extensive PPO directory) without the extensive restrictions imposed by HMO-type plans.

Please click on the following lonks to jump to specific topics.

  1. How a Health Savings Account Works
  2. Who can get an HSA?
  3. How much can I contribute annually to an HSA?
  4. Can any high-deductible health insurance policy qualify for an HSA?
  5. How and where can I open a health savings account?
  6. Would I fund an HSA with pre- or post-tax dollars?
  7. Do the tax benefits phase out at certain income levels?
  8. If my employer offers both, can I fund my flexible spending plan, too?
  9. What happens if I want to withdraw the money for nonmedical expenses after age 65?
  10. Can a couple who is planning to retire early open an HSA?
  11. Do contributions to an HSA in any way affect one's ability to contribute to an individual retirement account?

 

How an HSA Works

Take the money currently spent on a high cost traditional health plan and split it like this: Put a portion towards a low cost higher deductible policy and deposit the balance into a tax-deductible HSA.
The savings accounts should be used to help pay smaller covered medical expenses until the deductible is met; should the need arise, the high deductible insurance policy takes care of covered medical expenses exceeding the deductible


Who can get an HSA?

Anyone under age 65 who buys a qualified high-deductible policy can open an HSA. You can't be covered by another health insurance policy that isn't a qualified high-deductible plan (either as an individual or a dependent), although you can still have other disability, dental, vision and long-term care insurance policies.

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How much can I contribute annually to an HSA?

You can contribute in 2006 the amount of the deductible, up to $2,700 for singles and $5,450 for families, each year to your HSA. And if are 55 or older, you can put in an extra $700.

In 2007 you can contribute up to $2,850 for individual coverage or $5,650 for families (people age 55 and older can make an extra catch-up contribution of $800 in 2007). Legislation approved by Congress December 9 will allow you to contribute up to these limits even if your insurance deductible is less.

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Can any high-deductible health insurance policy qualify for an HSA?

Any high-deductible health insurance policy can qualify, as long as it meets the IRS requirements. The deductible must be at least $1,050 for individuals or $2,100 for families, and the annual out-of-pocket expenses cannot exceed $5,250 for an individual or $10,500 for a family, including the deductible and co-payments (but not premiums). So individuals can buy high-deductible policies on their own, or through their employers.

In 2007 your health insurance policy must have a deductible of at least $1,100 for individual coverage or $2,200 for families to qualify as an HSA-eligible policy. You can then contribute up to the amount of the deductible each year.

If you're buying a plan on your own, be sure to ask your health insurance company if it qualifies, says Victoria Bunce, research and policy director for the Council for Affordable Health Insurance.

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How and where can I open a health savings account?

It depends on if you're buying coverage on your own or getting it through your employer.

On your own. You can find a list of health insurance companies offering HSA-eligible plans in your state at HSAInsider.com or HSADecisions.org. You can compare several companies policies in most states at eHealthInsurance.com, or can search for a local agent who knows which policies are available in your area at the National Association of Health Underwriters Web site. The list of companies offering HSA-eligible plans continues to grow every month.

Through your employer. If you get health insurance through your employer, you may have seen an HSA-eligible option during last-year's open-enrollment period (generally in the fall). If not, talk to your benefits manager to see if HSAs will be on your health insurance menu. Choosing an HSA could knock down your share of premiums significantly, and some employers may choose to fund all or part of the HSA for you -- perhaps even adding a 401(k)-style match.

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Would I fund an HSA with pre- or post-tax dollars?

If your employer offers a high-deductible health insurance policy, you may be able to make pretax contributions, like you would with a flexible-spending account. If you open the HSA on your own, your contributions will be deductible when you file your taxes, even if you don't itemize.

For 2007, as a result of legislation passed December 9 (and expected to be signed by the President soon), you can deduct up to $2,850 for individuals, $5,650 for families. The dollar amount of your tax deduction no longer will be restricted to the amount of your insurance deductible.

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Do the tax benefits phase out at certain income levels?

Unlike many other tax breaks, there aren't any income limits. Anyone under age 65 who buys a qualified high-deductible policy can open an HSA.

What's the difference between the new HSAs and the flexible-spending accounts? It seems they are for the same purpose.

The tax benefits of both plans are quite similar, but there are several differences. The biggest and most important difference is that your HSA balances can roll over from year to year and continue to grow tax-deferred.

Money in your flex plan must be spent by the end of the plan year or you lose it. That may sound like a big negative, but flex plans can save you a lot of money even if you don't spend every nickel. Also, you can open a flexible-spending account only if the plan is offered by your employer, and you don't need to have a high-deductible health insurance policy.

Legislation passed by Congres December 9, 2006, will let you make a one-time transfer of funds tax free from a flexible-spending account to an HSA. Changes to the law also will allow individuals to make a one-time tax-free direct transfer of funds from an IRA to an HSA (up to the HSA annual contribution limit).

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If my employer offers both, can I fund my flexible spending plan, too?

No. You cannot have an HSA if you use a flexible-spending account to pay health-care costs or if you have other medical coverage (say, through a spouse's policy). However, if your flex plan restricts reimbursements to wellness care (such as annual physicals) and vision and dental care, you can have an HSA, too.

If I set up HSA through my employer, what happens if I switch jobs?

You can keep the money in an HSA account even after you leave that job, similar to a 401(k). But you will get stuck with a 10% penalty -- plus an income-tax bill -- if you use any of the money for nonmedical expenses before age 65.

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What happens if I want to withdraw the money for nonmedical expenses after age 65?

You won't be hit with the 10% penalty if you use the money for nonmedical expenses after age 65, but you would still have to pay income taxes on the money. Keep in mind that you can continue to withdraw money from the account tax-free for qualified medical expenses after age 65.

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Can a couple who is planning to retire early open an HSA?

Sure. Anyone under age 65 can contribute to an HSA if he or she buys a high-deductible health insurance policy, and you can contribute an extra $700 in 2006 if you're 55 or older; in 2007 it's $800. This catch-up contribution amount will increase by $100 per year until it reaches $1,000 in 2009.

You can't make new HSA contributions after age 65, but you can still use the money in your account tax-free for medical expenses at any age. You'll owe income taxes on the money -- but no penalty -- if you withdraw the money for nonmedical expenses after age 65.

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Do contributions to an HSA in any way affect one's ability to contribute to an individual retirement account?

No. Your HSA contributions won't affect your IRA limits -- $4,000 per year or $4,500 for those over 50. It's just another tax-deferred way to save for retirement.

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