Credit: Shutterstock photoFor many employees working for large organizations, open enrollment is a time when they can make changes to their benefits, most notably their health insurance plan. More and more employers are now offering high-deductible health plans that can be paired with a health savings account (HSA). Although these plans are less common than traditional insurance plans, the benefits afforded with an HSA should not be ignored. Before you re-enroll in the same plan as last year, take a few minutes to learn about the advantages an HSA has to offer.
What is a Health Savings Account?
An HSA is a savings account that can be used to pay for qualified medical expenses. However, unlike most savings accounts, contributions to an HSA are tax-deductible. This means more of your income stays in your pocket. Furthermore, these accounts often have the option to keep the funds in an FDIC interest-bearing account and/or invest in a variety of mutual funds. These contributions, and associated interest or other earnings, accumulate tax-free in your account until needed.
In the meantime, most plans provide you with a debit card that can be used when a medical expense comes about. If you get lucky and have an event-free year, don't worry – unlike a flexible spending account (FSA), the balance in an HSA rolls over from year to year so you don’t have to worry about losing any unused funds.
Account Eligibility
Unfortunately not everyone is eligible to contribute to an HSA. First and foremost you must be covered under a high-deductible health plan (HDHP). As the name implies, an HDHP is a medical plan with an annual deductible of at least $1,350 for single coverage and $2,700 for family coverage. Second, you cannot be covered by any other health insurance (except for some permitted coverages) or enrolled in Medicare. Lastly, you can’t be claimed as a dependent on someone else’s income tax return. (For related reading, see: How to Qualify to Contribute to an HSA.)
Contribution Limits
Each year participants can contribute up to $3,450 for a single plan or $6,900 for a family plan. Those who are 55 or older by the end of the year can contribute an extra $1,000. It should also be noted that if your employer makes contributions on your behalf that are excludable from your income, you must reduce your contribution by the same amount.
Qualified Medical Expenses for an HSA Plan
The IRS defines medical expenses as, “the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body.” This includes insurance premiums, dental treatment, eye exams, hearing aids, and everything in between. For a complete list of what is covered, review IRS Publication 502.
A few expenses that are not qualified include babysitting, cosmetic surgery, health club dues, nonprescription drugs, nutritional supplements, teeth whitening and veterinary fees.
3 Tax Advantages
An HSA has three distinct tax advantages that separate it from any other savings account or retirement plan.
- Contributions (other than employer contributions) are either pre-tax via payroll deductions or deductible on your individual income tax return, regardless of whether or not you itemize your deductions.
- If your employer does fund your HSA, those contributions aren’t included in income. Any growth, interest or dividends within your account are tax-sheltered.
- Distributions from an HSA used to pay qualified medical expenses aren’t taxed.
In other words, an HSA allows for tax-deductible contributions, tax-free growth and tax-free withdrawals. (For related reading, see: How and When to Use Your HSA Funds.)
Forward Thinking
In addition to the benefits mentioned above, an HSA can also serve as a way to supplement medical costs in retirement. Investing in an HSA early in your career may allow for decades of growth and lead to a sizable balance by the time you reach retirement. While you may not be eligible to contribute once retired, the account balance can continue to grow as there are no minimum distribution requirements. When needed, the HSA can be used to cover Medicare premiums, prescriptions, hospital visits and even long-term care.
Clearly there are a lot of benefits to having an HSA, but it’s important to understand it is not for everyone. While high-deductible health plans generally have lower monthly premiums, the deductible, or amount you pay before your insurance plan starts to pay, is higher than with a traditional plan. This could create a problem if you do not have enough money saved in your HSA to cover these out-of-pocket expenses. Another downside to HSA plans is the recordkeeping requirements to prove your withdrawals were in fact used for qualified medical expenses. Understanding how an HSA plan works can go a long way towards helping you make the right decision for you and your family during open enrollment.
(For more from this author, see: How Can You Make the Most of Your 401(k)?)
This article was originally published on Investopedia.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
