A Health Savings Account (HSA) is a tax-advantaged savings account that is designed to help individuals and families with high-deductible health insurance plans (HDHPs) save money for medical expenses. HSAs offer several benefits, including tax advantages and the flexibility to use the funds for qualified medical expenses. Here’s how an HSA works:
- Eligibility:
- To open and contribute to an HSA, you must be covered by a high-deductible health insurance plan (HDHP). HDHPs typically have higher deductibles and lower premiums than traditional health insurance plans.
- You cannot be covered by other health insurance that is not an HDHP, Medicare, or claimed as a dependent on someone else’s tax return.
- Contributions:
- You or your employer can make contributions to your HSA. Contributions are tax-deductible, meaning they reduce your taxable income for the year.
- There are annual contribution limits set by the IRS. These limits may change from year to year. In 2021, for example, the contribution limit for an individual was $3,600, and for a family, it was $7,200. For those aged 55 and older, there is a catch-up contribution allowance.
- Contributions can be made with pre-tax dollars if done through payroll deductions, or you can make tax-deductible contributions when filing your income tax return.
- Tax Advantages:
- HSA contributions are tax-deductible, reducing your taxable income.
- The money in your HSA grows tax-free.
- Withdrawals used for qualified medical expenses are tax-free.
- Any interest or investment earnings within the HSA are tax-free.
- Using the HSA Funds:
- You can use the funds in your HSA to pay for qualified medical expenses, including deductibles, co-payments, prescription medications, dental and vision care, and other eligible healthcare costs.
- It’s important to keep receipts and records of your medical expenses in case of an IRS audit.
- You can also use HSA funds for non-medical purposes, but these withdrawals are subject to income tax and a 20% penalty if you’re under 65. After age 65, non-medical withdrawals are taxed as regular income without the penalty.
- Portability:
- HSAs are portable, meaning you can keep the account even if you change employers or health insurance plans.
- The money in your HSA is yours to keep, and it continues to grow tax-free year after year.
- Retirement:
- After age 65, you can withdraw funds from your HSA for any purpose without the 20% penalty. However, if the funds are not used for qualified medical expenses, they will be subject to regular income tax.
- Record Keeping:
- It’s important to keep accurate records of your HSA contributions, withdrawals, and qualified medical expenses to ensure compliance with IRS rules.
HSAs can be a valuable tool for saving money for healthcare expenses while enjoying tax benefits. However, it’s essential to understand the rules and limitations associated with HSAs and use them wisely to maximize their benefits. Consulting a tax professional or financial advisor can help you make informed decisions regarding your HSA.