A health savings account (HSA) is a trust account into which tax-deductible contributions can be deposited by qualified taxpayers who have high-deductible medical insurance plans. These accounts are set up at a bank or other financial institution. Income earned on the HSA balance is income tax-free. The funds from these accounts are then used to pay qualified medical expenses not covered by an eligible individual’s medical insurance. If these funds are not used, they roll over year to year. At age 65, the funds can be used like a retirement plan (taxable when withdrawn, but not subject to a withdrawal penalty) or continue to be saved for future medical expenses. Since the contribution is an above-the-line deduction, a taxpayer need not itemize to take advantage of this tax break. The rules discussed here are applicable to federal tax returns and may not apply to your particular state.
Who qualifies for an HSA? An eligible individual is one who is covered by a high-deductible plan (defined below) and, while covered by that high-deductible plan, is not also covered by another plan that does not have a high deductible. For purposes of determining if there is coverage that does not have a high deductible, the law allows certain types of coverage such as worker’s compensation, insurance for a specific condition, dental care, vision, long-term care, and certain others to be disregarded.
Any eligible individual, whether employed, unemployed or self-employed, may contribute to an HSA. Unlike IRAs, there is no requirement that the individual have compensation and there are no phase-out rules for high-income taxpayers.
High-deductible Plans – For 2014, high-deductible plans are defined as those with the following deductible amounts:
- Qualified Medical Expenses – Qualified medical expenses that can be paid from these accounts are generally defined as those that would be allowable as a medical deduction on your tax return.
- Contribution Limits – The eligibility and contribution amounts for these accounts are determined monthly. Therefore, during any month in which you qualify, you would be entitled to contribute 1/12 of the annual limits. However, an eligible individual who establishes an HSA plan during the year and is still an eligible individual during the last month of the year (December) can contribute the full-year amount (does not need to prorate the contribution). For 2014, the annual limits (note these values are adjusted annually for inflation) are:
- $3,300 for single coverage plans;
- $6,550 for family coverage plans; and
- $1,000 additional for individuals age 55 or older.
Individuals entitled to benefits under Medicare and those claimed as a dependent on another person’s tax return cannot make contributions. Contributions can be made as late as the due date of the tax return without extensions, and contributions in excess of the allowable amounts are subject to an annual 6% excise penalty.
If you are eligible for an HSA and your employer contributes to your HSA, the contributions (within the limits) are treated as employer-provided coverage for medical expenses under an accident or health plan and are excludable from your gross income. They are not subject to income tax or FICA withholding (or FUTA tax). If contributions to your HSA are made through your employer’s cafeteria plan, the contributions are treated as employer contributions. An employee may not deduct the employer’s HSA contributions as either an HSA contribution or a medical expense on his or her return.
Example: John, a single taxpayer, age 58, begins a high-deductible health plan with an annual deductible of $5,000 in March of 2014. He continues in the plan through the end of the year. He may set up an HSA, and is eligible to contribute the full year’s maximum of $4,300 ($3,300 plus $1,000 for being over 55) since he was in the high-deductible health plan in December. John’s employer does not contribute to the HSA. When John files his 2014 tax return, he claims an above-the-line deduction of $4,300. If John were in the 25% tax bracket, he would realize a tax savings of $1,075.
In January of 2015, John has $800 worth of medical expenses that are not covered by his health plan, so he withdraws $800 from his HSA to pay for them. The $800 distribution is not taxable income, but he can’t include the $800 as a medical expense for itemized deductions.