Health-y Savings Accounts

Health savings accounts (HSA) were created in 2003 to allow people covered by high-deductible health plans (HDHP) to set money aside for medical expenses on a tax-preferred basis. Enrollment in HSAs is growing and, according to research by health-insurance–industry organization AHIP, reached 21 million members in 2017. HSAs allow you (or your employer) to make tax-deductible or pretax contributions that can be withdrawn tax free if the money is used to pay for qualified medical expenses.

In addition, unused funds in these accounts roll over from year to year and can eventually be withdrawn as taxable retirement income. Therefore, they not only provide a means to pay for medical insurance and expenses but can also function as an additional avenue for retirement savings. (For more, see Pros and Cons of a Health Savings Account (HSA).) 

Not everyone is eligible to open an HSA. According to IRS Publication 969 you must meet the following requirements:

• You must be covered by a high-deductible health plan (HDHP). For 2018 and 2019 the minimum deductible for your HDHP must be at least $1,350 for self-only coverage and $2,700 for family coverage. The maximum deductible plus out-of-pocket expenses allowed for 2018 is $6,650 for single coverage and $13,300 for families. For 2019 the maximum for singles goes up $100 to $6,750 and $200 for families to $13,500.
• Neither you nor your spouse (for family coverage) can have access to any other type of standard group health insurance coverage. This does not include limited-coverage insurance, such as dental, vision and disability. Other coverage for dependents is also allowed. Whether you or your spouse participates in the other plan is irrelevant; eligibility for the plan alone disqualifies you from health savings account participation.
• If you or your spouse is covered by Medicare, the covered individual may not contribute to an HSA.
• You can’t be claimed as a dependent on someone else’s tax return. 

For 2018 the contribution limit for health savings accounts is $3,450 for singles and $6,900 for families. For 2019 contribution limits go up $50 to $3,500 for singles and up $100 to $7,000 for family coverage. If you and your spouse are age 55 by the end of the tax year, you can each make an additional $1,000 contribution, raising the family coverage total contribution limit in 2018 to $8,900 and $9,000 in 2019. 

The contribution amount can exceed the deductible from the HDHP and, while you can have more than one HSA, your total contributions can’t exceed the limits noted above. You can make your contributions at any time during the year in any amount desired within the prescribed limits, but the financial institution administering the account may impose a minimum required deposit or balance. 

If your employer offers an HSA, especially if the employer makes pretax (including matching) contributions on your behalf, that may be the best way to go. One additional advantage of an employer-sponsored HSA is that all contributions – including yours – can be made pretax.

With an individual HSA, obtained through a bank, credit union, brokerage firm or insurance company, your contributions typically go in after you pay taxes on them. You then deduct those contributions on your taxes the following April. Whether you sign up for an HSA through your employer or individually, you must account for all contributions (including those made by your employer) each year at tax time using IRS Form 8889. 

Health savings accounts provide the following tax advantages:

• All contributions made to an HSA are classified as above-the-line (pretax) deductions on your 1040, just as with individual retirement account (IRA) or other retirement plan contributions. While you don’t need to itemize these contributions, they must be accounted for on IRS Form 8889 (see above).
• All long-term care insurance premiums you pay for a tax-qualified policy are deductible within certain limits if you are 65 or older. (For more, see Should You Buy Long-Term Care Insurance?)
• Your regular health and medical insurance premiums can also be deductible if you are under 65 and unemployed.
• All distributions from your HSA used to pay for qualified medical expenses are tax free. Qualified medical expenses include prescription drugs, over-the-counter medicines for which you have a prescription, insulin and any expenses that qualify as a medical or dental expense under IRS Publication 502 (Medical and Dental Expenses.)
• Money contributed to an HSA can be invested just as you can with an IRA. Investment options depend on the specific HSA administrator. This means that over time it is possible to achieve tax-free income generated solely by the investment portfolio within the account.

HSAs have increasingly become a retirement savings option, especially for younger workers. The ability to defer taxes on savings that can be used now for medical expenses and in the future for retirement is simply too appealing to pass up.

Money you put in your HSA that you don’t use for medical expenses continues to accrue earnings and interest tax free until withdrawn. If you withdraw funds before age 65 and don’t use them for medical expenses, you will be subject to regular taxes and possibly a 20% tax penalty. Once you reach 65, however, distributions are tax free for medical expenses and subject to regular income tax only for nonmedical expenses.

Investment options are up to the individual HSA administrator and can range from simple interest, as with a savings account, to a menu of mutual funds or other investment vehicles. If you plan to use your HSA for retirement, this could play a role in your decision to go with an employer plan or an individual plan with more options. An HSA is probably not a viable stand-alone retirement savings option, but it might make sense as a supplement to a company 401(k) or traditional or Roth IRA. (For more, see How to Use Your Health Savings Account (HSA) for Retirement.) 

​​​​For those who qualify, HSAs can resolve the financial dilemma of how to both save for retirement and pay current or future medical bills. This is particularly true when long-term care may be needed. While the cost of a nursing home or other skilled care can be staggering, the opportunity cost of paying for long-term care insurance is also very high. Health savings accounts can be valuable in these cases, as shown in the following example:

Joe and Betty Smith own a small, successful jewelry business. Joe is 55 and Betty is 48. Neither has access to group health insurance, but they do have an HDHP. Joe has had a respiratory problem for several years, and Betty's family has a history of heart disease. They are currently contributing to a self-employed 401(k), but are concerned about the possible medical or long-term care bills that they may have to pay in the future. They are not sure if they have sufficient assets or income to fund both their retirement and their possible health costs. 

The solution, since they have an HDHP, is to open a health savings account. They can make the maximum allowable contribution to the account each year, plus an additional catch-up contribution for Joe. The premiums that they pay for their HDHP are deductible, as well. Furthermore, if they decide to pay for long-term care insurance, most or all of the premiums can be paid for with distributions from the account. Because contributions are deductible and distributions are tax-free, the Smiths are able to deduct the most or all of the cost of their long-term care insurance policies, which otherwise would not have been possible.

Finally, all money contributed will grow tax free until used for medical bills – or tax deferred until used as retirement income. One way or another, the Smiths are certain to be able to use the money constructively. This will simplify and improve the Smiths' ability to plan for their retirement.

The House Ways and Means Committee recently passed bills designed to expand health savings accounts by increasing contribution limits and the number of people qualified to sign up for them. One bill would increase contribution limits up to the maximum deductible and out-of-pocket limits; one would improve the ability of spouses to contribute.

Another would let seniors who are still working continue to contribute, even after they reach the age of 65 and are on Medicare. Still others would increase the range of approved treatments and services and expand the definition of HDHPs to include Affordable Care Act (ACA) bronze and catastrophic plans. Observers believe many of these bills could pass the House of Representatives, but would likely stall in the Senate due to Democratic opposition. 

Health savings accounts ultimately represent a major step forward in tax relief for those willing to take on the risk of a high-deductible health plan. Those who qualify have almost nothing to lose by opening one, as all contributions are guaranteed to be used one way or another. The only caveat would be if you need to withdraw from your HSA for nonmedical expenses before you turn 65 and subject yourself to a 20% tax penalty.