Health Savings Accounts

With rising health care costs, you may not know about the benefits of starting a health savings account, but you should.

Formed under the Medicare Prescription Drug Improvement and Modernization Act of 2003, HSAs are tax-advantaged savings accounts intended to be used in conjunction with high-deductible health care plans. As of 2016, HSAs must be used with plans with deductibles of at least $1,300 for individuals and $2,600 for families.

HSAs share some traits with other tax-favored plans, like IRAs and 401ks, such as annual contribution limitations. For 2016, yearly contributions are capped at $3,350 for individuals and $6,750 for families; an additional $1,000 catch-up contribution is permitted for those ages 55 and older. Unique to HSAs is the “triple tax advantage” they offer. Contributions, gains and qualified withdrawals for medical expenses are all tax-free. The tax savings HSAs offer are one of the top reasons for their popularity, according Nick Coiner, vice president of TFA Benefits – A TowneBank Company.

HSAs are intended to cover medical expenses, but they may be used for non-medical expenses with tax implications. For those ages 65 and younger, non-qualified expenses constitute taxable income and a 20 percent penalty tax is assessed. After age 65, non-qualified expenses are still taxed as income, but the 20-percent penalty tax is waived, and according to Coiner, “you have the best retirement account with no minimum required distribution and the ability to use it tax free.”

The list of qualified medical expenses, outlined in detail in IRS Publication 502, is exhaustive and includes things traditional health care plans typically don’t cover, says Coiner. Examples include stop-smoking programs, pregnancy tests, hearing aids, eye exams, acupuncture, fertility enhancement, vision correction surgery and weight-loss programs. HSA funds may also be used for the medical expenses of the account holder’s spouse and tax dependents.

The popularity of HSA plans is rising, according to an annual census conducted by America’s Health Insurance Plans (AHIP)—a national trade association representing about 1,300 health insurance agencies. Census responses from 64 insurance companies that sell HSA-eligible high-deductible health plans show a 13 percent increase in HSA enrollees from January 2014 to January 2015, with more than 19 million utilizing HSAs. Coiner attributes the trend to mandates imposed on employers by the Affordable Care Act, the rising premiums of traditional health care plans and the tax savings HSAs offer.

People are also realizing, Coiner says, to view HSAs as “shadow” IRAs/401Ks. “[HSAs] can be used the same way as a traditional 401K and IRA post-65 without any required distributions or penalties,” he says, adding that funds from an IRA may be transferred to an HSA once in a person’s lifetime, up to the annual maximum. “That saves a few thousand in taxes post-retirement and makes the money available today for eligible medical expenses without any penalty for early withdrawal, says Coiner.”