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You Can Use Health Savings Accounts to Reduce the Cost of Your Medical Care

welch julie 16Health Savings Accounts (HSAs) are similar to individual retirement accounts (IRAs) for medical expenses. Both individuals and employers can contribute to HSAs for eligible individuals.

If you are eligible, you can make deductible contributions to an HSA that is administered by a financial institution or insurance company. The money in the plan, which you may invest in certificates of deposit, stocks, bonds, mutual funds, and similar investments, grows tax-free. Distributions you take to pay for qualified medical expenses are tax-free. If you take a distribution that you do not use to pay for qualified medical expenses, you must pay tax plus a 10% penalty on the distribution amount. The 10% penalty will not apply if you die, become disabled, or reach age 65.

To be eligible for an HSA, you must meet several conditions. First, you must be covered under a high-deductible health insurance plan. For self-only coverage for 2015, the plan must have an annual deductible of at least $1,300 and annual out-of-pocket expenses (deductibles, copayments, and other amounts, but not premiums) not exceeding $6,450. For family coverage for 2015, the plan must have an annual deductible of at least $2,600 and annual out-of-pocket expenses not exceeding $12,900. Except for preventive care, the plan may not pay benefits until you or your family has incurred annual covered medical expenses in excess of the minimum annual deductible.

Second, you may not be covered by any other health plan that is not a high-deductible health plan, including your spouse’s plan, your parent’s plan, or Medicare. However, you may still be covered under workers’ compensation laws, insurance for your auto and home, insurance for a specified disease or illness, insurance that pays a fixed amount per day of hospitalization, and insurance covering accidents, disability, dental care, vision care, or long-term care.

Third, you may not be claimed as a dependent on another person’s tax return.

Qualified medical expenses that you can pay using your HSA are those that would be deductible for tax purposes as medical expenses. These expenses may be for you, your spouse, or your dependents, but they cannot be covered by insurance. You cannot have your HSA pay your health insurance premiums, since they are not qualified medical expenses. However, your HSA can pay for qualified long-term care insurance, COBRA health care continuing coverage, and your spouse’s or dependents’ premiums for Medicare Part A or B coverage.

You may deduct your contribution to your HSA up to $3,350 for 2015 for self-only coverage ($6,650 for 2015 for family coverage). If you are 55 or older, you can contribute $1,000 extra to your HSA.

You are 40 years old, single, and self-employed. You are covered under a high-deductible health insurance plan. In January, you open an HSA at your local bank by depositing $1,500, the annual deductible for your high-deductible health plan. You direct the bank to invest the $1,500 in a mutual fund, which has $100 of earnings for the year. During the year, you pay $700 for qualified medical expenses. You can deduct the $1,500 you contributed to the account. You do not pay tax on the $100 earned from the mutual fund or the $700 you withdrew to pay for medical expenses.

Similar to IRAs, you have until April 15th to make an HSA contribution for the previous year. If you make your HSA contribution between January 1st and April 15th of the following year, you must indicate that you want your contribution to apply to the prior year or it will automatically be applied to the current year.

Once during your lifetime, you may fund your HSA with a tax-free rollover from your IRA. The rollover amount is limited to the maximum deductible contribution to your HSA. This may be beneficial if you do not have the cash to put into your HSA. You may also be able to roll over amounts in your Flexible Spending Accounts and Health Reimbursement Accounts into your HSA in certain circumstances.

NOTE: Your employer may contribute to your HSA and can pay the premiums for your high-deductible health plan on a deductible basis. Your employer’s contributions are not taxable to you. This approach provides income tax and employment tax savings to you and your employer.


Julie Welch (Runtz), CPA, CFP, and Randy Gardner, LLM, CPA, CFP, are the authors of 101 Tax-Saving Ideas, 10th edition.