A Health Savings Account (HSA) is a great way to reduce your taxes now and save for medical expenses later in life. While the HSA is similar to the Flexible Spending Account, the HSA has the advantage that you do not have to “use it lose it” all in one year. This makes sense for people who have limited medical expenses when they are younger, but more as they get older. Many retired people find health costs increase as they age, and the HSA is a way to save for medical expenses in the future.
How Does it Work? The individual makes tax-deductible contributions to the HSA (limitations apply), savings grow tax-deferred, and distributions for “qualified medical expenses” are tax-free. HSAs must be used in conjunction with a “High Deductible Health Plan” (HDHP). A HDHP is an insurance plan with higher deductibles and out-of-pocket expenses (including deductibles, co-pays, and prescriptions). You will need to show how your HSA money has been spent, so make sure to track expenses as you incur them.
HSA Rules Contributions to the HSA can be made by the employer or the individual. If made by the employer, it is not taxable to the employee (excluded from income and wages). If made by the individual, it is an “above-the-line” deduction on your tax return. There are no income limitations or earned income requirements in order to contribute to an HSA.
Distributions are tax-free, if used for “qualified medical expenses”. Distributions not used for “qualified medical expenses” are included as taxable income and assessed a 10% penalty.
An individual is eligible for a HSA, if they are not covered by other health insurance, not enrolled in Medicare, or cannot be claimed as a dependent on someone else’s tax return.
Conclusion Fees and account features can vary widely from plan to plan. For many people, making contributions to a money market makes sense, since they will most likely use the dollars within a year. For others who plan to build their accounts for the future, it may be better to invest in an account that offers mutual funds. Since HSAs are governed by many tax rules, make sure you fully understand them before getting one. To learn more about HSAs visit the U.S. Treasury Department website at http://www.ustreas.gov/offices/public-affairs/hsa/ or talk with a qualified financial advisor.