Preface: “Do not save what is left after spending, but spend what is left after saving”. – Warren Buffett
Health Savings Accounts (HSAs) in a Nutshell
Credit: Benjamin Gelbart
A Health Savings Account (HSA) is a tax advantaged savings account available to taxpayers who participate in a High Deductible Health Plan (HDHP) and who are not enrolled in any other health insurance, including Medicare.
An HSA is an investment account similar to a retirement savings account or a college savings account. The money contributed to it is invested and the investments grow tax-free for the life of the account. Withdrawals from the account are also tax-free as long as they are used for the intended purpose of the account, which in the case of an HSA is qualified medical expenses.
Unlike money contributed to a Flexible Savings Accounts or cafeteria plan, funds in an HSA are never lost just because they are not used by a certain date.
While a taxpayer cannot open an HSA without having an HDHP, once money has been contributed to the HSA, it continues to be available for withdrawal and is tax-free if used for qualified medical expenses even after the taxpayer is no longer enrolled in the HDHP and is no longer eligible to make contributions. Nor is there any required minimum distribution. The funds may be used to cover qualified medical expenses originating at any date after the HSA was established and funded. HSAs can even be used to reimburse the taxpayer for expenses that have already been paid out of pocket.
The tax benefits of HSAs are threefold:
– Contributions are deducted from your taxable income.
– The contributions, once invested, grow tax-free.
– Withdrawals from the account are tax-free as long as they are used for qualified medical expenses.
HSAs come in two flavors: individual and family. The family HSA has a deductible, annual contribution limit, and annual withdrawal limit that are larger than those for an individual: For 2023: Individual HSA
annual contribution limit $3,850 ($4,850 if age > 55) Deductible $1,500 withdrawal limit $7,500. Family HSA annual contribution limit $7,750 ($8,750 if age > 55) Deductible $3,000 annual withdrawal limit $7,500.
Note that combined contributions of a married couple cannot exceed the family coverage limit.
Excess contributions are subject to an excise tax of 6%. This excise tax is avoided if the excess contribution is withdrawn before the end of the year. Non-qualified withdrawals are subject to ordinary income tax plus a 20% penalty. The penalty (but not the ordinary income tax) is waived for taxpayers who are disabled or are of age 65 or older.
Taxpayers who have an HDHP through their employer will usually have contributions to their HSA deducted automatically from their paychecks. The contributed amount will not be included in their taxable income. The total amount of contributions made in a tax year will appear on the taxpayer’s W-2 in Box 12 with the code “W.” Because this kind of contribution is done at the payroll level, it also reduces FICA (Social Security and Medicare) payroll tax.
Taxpayers may also make direct contributions to their HSAs, as long as the total amount of contributions does not exceed the annual limit. Direct contributions can then be deducted from taxable income at tax time.
Tax Strategy: Another way to contribute to an HSA is to roll over funds from an IRA. However, this can can be done only once in a taxpayer’s lifetime.