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What is a health savings account (HSA)?
A health savings account (HSA) is a savings vehicle established to set aside funds tax free to pay for health care expenses. HSAs allow individuals who have high-deductible health plans (HDHPs) to save money for health care expenses tax free.
Who can establish an HSA?
Generally, if you are covered under a high- deductible health care plan (HDHP), you are eligible to establish a Health Savings Account (HSA). In 2012, a qualifying high-deductible health care plan (HDHP):
1) Has an annual deductible of at least $1,200 for individual coverage or $2,400 for family coverage (unchanged from 2011)
AND
2) Limits annual out-of-pocket expenses (e.g., co-pays, deductibles) to $6,050 for individual coverage or $12,100 for family coverage.
Caution: Even if you meet the main two criteria above, there are some folks who will not be eligible to open an HSA. Consult an insurance professional before you act.
How do you establish an HSA?
An HSA is a tax-exempt trust or custodial account that can be established through any qualified trustee or custodian, including a bank; most folks use a local bank, an insurance company, or a third-party administrator. You can open an HSA on your own or, if available, through your employer.
Who can make contributions to an HSA?
You, your eligible family members, or others who wish to do so can make contributions to your HSA. If you're employed, your employer may also make contributions to your HSA. Contributions may be made directly or through salary reduction under a cafeteria plan (if offered by your employer). However, no contributions can be made to your HSA once you retire.
How much can you contribute to an HSA?
For tax year 2012, you can contribute up to $3,100 for individual coverage or $6,250 for family coverage, to your HSA.
You may also be eligible to make additional "catch-up contributions" to your HSA if you are 55 or older. The catch-up contribution amount is $1,000. If eligible, both you and your spouse can make separate catch-up contributions to an HSA. However, no regular or catch-up contributions can be made once you reach age 65 and are enrolled in Medicare.
Can your contributions earn interest?
Yes. As the account owner, you can direct your contributions to a savings or investment option offered by the qualified trustee, bank, or custodian of your HSA. Any interest and investment earnings on contributions grow tax deferred until withdrawn and, like contributions, will be tax free when withdrawn if used to pay qualified medical expenses.
How are contributions taxed?
Individual contributions you make to your HSA that do not exceed the maximum contribution limit are tax deductible on your federal income tax return. Because you deduct these contributions "above-the-line" when computing your adjusted gross income, you can deduct HSA contributions even if you don't itemize. You can also deduct contributions made by a family member on your behalf.
If your employer makes contributions to your HSA, these are excludable from your gross income. Any contributions made through a cafeteria plan are treated as employer contributions. However, you cannot deduct employer contributions.
How are distributions taxed?
You can withdraw money from your HSA for qualified medical expenses for yourself, your spouse, and your dependents. Distributions from an HSA for qualified medical expenses are not taxable. However, distributions for nonqualified expenses (expenses other than qualified medical expenses) are considered taxable income and are subject to an additional 20 percent penalty tax. So you can't use this money for a new car without paying taxes and a penalty!
What are qualified medical expenses?
Qualified medical expenses are health care expenses, as defined by Internal Revenue Code 213(d) that are paid by you, your spouse, or your dependents. These include laboratory fees, prescription and nonprescription drugs, dental treatment, ambulance service, eyeglasses, and hearing aids, as well as many other health care expenses. HSA funds may also be used to cover health insurance deductibles and co-payments.
Caution: Beginning in 2011, over-the-counter (OTC) medications are no longer considered a qualified medical expense for purposes of HSAs, FSAs, HRAs, and Archer MSAs. However, OTC medicines prescribed by a physician and insulin will still be considered qualifying expenses.
Generally, health insurance premiums, including HDHP premiums, are not qualified expenses, except for the following types of health coverage: (1) COBRA coverage; (2) Qualified long-term care insurance; (3) Health coverage maintained while receiving unemployment compensation; and (4) Retiree health insurance other than a Medicare supplemental policy (Medigap).
What happens to funds remaining in your HSA?
At the end of the year:
One of the advantages of HSAs is that unlike FSAs, HSAs do not have a "use it or lose it" provision. Funds remaining in your account at the end of the year are not forfeited and can continue to accumulate tax free year after year until withdrawn.
If you change jobs:
An HSA is portable. Because the account is yours, you can keep it and continue to make contributions even if you change employers or leave the workforce.
If you divorce:
If all or part of your interest is transferred to your spouse as part of a divorce settlement, it will not be considered a taxable transfer, and the transferred interest will continue to be treated as an HSA.
If you retire:
Although you can no longer open or make contributions to an HSA once you reach age 65 and are enrolled in Medicare, you can take tax-free distributions from your account to pay for medical expenses. You can withdraw funds from your account for nonmedical purposes without owing a penalty (although the amount you withdraw will be subject to income tax).
If you die:
Funds remaining in your HSA upon your death become the property of your designated beneficiary. If the beneficiary is your spouse, he or she becomes the account holder and the account remains an HSA. If the beneficiary is not your spouse, the account ceases to be an HSA as of the day of your death, and the fair market value of the funds is includable in your beneficiary's gross income.
Charter Oak Capital Management recognizes that there are some nuisances to Health Savings Accounts and that you may have questions regarding them. As always we are happy to help, especially as High Deductible Plans become more popular.
Sincerely,
The Charter Oak Team
