Consider an HSA When Choosing Health Insurance

For people who are self-employed or who do not receive health insurance through employers, open enrollment is their opportunity to shop for health insurance. Typically, the open enrollment period is from the beginning of November to the middle of December. There are many different plans to compare during this period, especially if your health insurance needs have changed.

Usually these options are referred to as "Bronze," "Silver," "Gold" or "Platinum" and classified as preferred provider organization (PPO), health maintenance organization (HMO), point-of-service (POS) or exclusive provider organization (EPO) plans. During open enrollment, you should compare the deductible, coinsurance and annual out-of-pocket maximums for each plan. In addition, you should consider opening a Health Savings Account (HSAs), another option for covering your your healthcare expenses.

However, HSAs are not health insurance. HSAs can also be used for people who get health insurance through their employer. (For more, see: Pros and Cons of a Health Savings Account.)

What is a Health Savings Account?

An HSA is a tax-exempt trust or custodial account you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur, according the the IRS. Like the IRA for retirement and the 529 plan for education, the HSA is designed to fund medical expenses. In my opinion, the HSA is the best type of account for current and future medical expenses and it can also be used as a great savings vehicle for retirement. 

Benefits of an HSA

The biggest benefit of an HSA is called the triple tax advantage:

• Contributions are tax deductible.
• Earnings on the money in the account are tax free.
• Distributions for qualified medical expenses are tax free.

Contributions to a traditional IRA may be tax deductible with income limitations, but distributions are fully taxable as ordinary income. Earnings and distributions are tax free for a Roth IRA owner who is older than 59 1/2, but contributions are after tax money. On the other hand, an HSA enjoys before-tax contributions without income limitations, tax-deferred growth and tax-free distributions for qualified medical expenses.

It's important to keep in mind that your health insurance premiums are generally not considered qualified medical expenses, except the premium you pay for Medicare and other healthcare if you are 65 or older. (For more, see: Rules for Having a Health Savings Account (HSA).

HSAs also offer these advantages:

• Unlike Flexible Spending Accounts (FSAs), which are generally use-it-or-lose-it accounts, the balance in HSAs can be carried forward until you use it.
• Unlike 529 plans, where you have to pay penalties when the distributions are not used for qualified education expenses, there is no additional tax penalty on distributions from HSAs after you reach age 65. You still need to pay ordinal income tax on the distributions not used for qualified medical expense, but there are no additional penalties.
• Unlike traditional IRAs, which are subject to required minimum distributions (RMDs) once you reach age 70 1/2, there is no RMD for HSAs.
• Unlike a 401(k), where your contributions are subject to Social Security taxes, contributions to an HSA through a payroll deduction generally are excluded from both federal income and Social Security taxes.

Drawbacks of an HSA

For most accounts with tax advantages, you have to follow certain rules in order to enjoy the benefits or else you will be penalized. For HSAs, you may have to pay your regular income tax, plus additional 20% tax penalties on distributions not used for qualified medical expenses unless you are disabled, reach age 65 or die.

Another limitation on HSAs is that the maximum contribution in 2018 is only $3,450 per year for an individual and $6,900 per year for a family plan. There is an additional $1,000 contribution allowed for people who are 55 or older at the end of the 2018 tax year.

The biggest drawback of HSAs (and the reason a lot of people don’t even know that they exist) is because of their stringent eligibility requirements.

Who is Eligible? 

You must meet these requirements in order to qualify for an HSA.

• You are covered under a high-deductible health plan (HDHP) on the first day of the month.
• You have no other health coverage except what is permitted under other health coverage.
• You are not enrolled in Medicare.
• You can’t be claimed as a dependent on someone else's tax return.

The key requirement here is the HDHP. In 2018, an HDHP requires a minimum annual deductible amount and a maximum limit on the sum of the annual deductible and out-of-pocket medical expenses. In 2018, the requirement is $1,350 and $6,650 for individuals and $2,700 and $13,300 for family coverage. Certain additional rules and exceptions may apply. 

You should easily be able to tell which health insurance plan is HSA-eligible from the name of the plan. 

Who is the Best Candidate for an HSA?

In general, a higher deductible and a higher limit on out-of-pocket expenses make an HDHP cheaper than non-HDHPs. However, if you regularly incur a lot of medical expenses every year, it might make more sense to have a non-HDHP with better health insurance coverage. The general answer is that the combination of an HDHP and HSA is usually best for people who do not expect a lot of medical expenses in the following year.

How to Open an HSA Account

You don’t need to file any forms with the IRS when you open an HSA account. However, you must file Form 8889 with your federal income tax return if there is any activity, including contributions, in your HSA during the tax year. You can open and make contributions to an HSA for the current tax year until the tax-filing deadline (usually April 15) of the following year. 

HSA providers are relatively limited and each have different features, fees, interest rates and investment options.

An HSA account may not work for you this year, but it may be beneficial in the future. For people who get health insurance through work, you could check with your HR department and ask whether your current plan is eligible for an HSA and whether they offer any additional HSA benefits. (For more, see: How to Effectively Utilize Health Saving Accounts.)

Disclosure: All written content in this article is for information purposes only. Opinions expressed herein are solely those of X and Y Advisors, Inc., unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.