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1. HSAs (Health Savings Accounts)

1. HSAs (Health Savings Accounts)

   Original Version: 3/5/2006
   Last Updated: 4/13/2008

   An HSA (Health Savings Account) is very different and much better than an FSA (Flexible Spending Account).

   An HSA is like an IRA, but for medical expenses as well as retirement.  The basic idea is to save money to pay future medical expenses tax-free, or to use tax-deferred after retirement.  The US law permitting this went into effect in 2004.  You can open such an account at any bank and start putting money into it, up to the following limits:

   • 2005:  $2650*/year (single) or $5250*/year (family)
   • 2006:  $2700*/year (single) or $5450*/year (family)
   • 2007:  $2850/year (single) or $5650/year (family)
   • 2008:  $2900/year (single) or $5800/year (family

   *  Before 2007, these amounts were further limited to the amount of your HDHP insurance deductible.  See details below.

   
   Like an IRA:

   1. It remains your money year after year (unlike an FSA, where you have to "use it or lose it" each year).
      
      
   2. It is tax-deferred (or tax free, see below), even if you don't itemize deductions on your federal tax return.
      
      
   3. The growth is also tax-deferred (or tax-free).
      
      
   4. You can keep accumulating as you go from job to job and/or insurance company to insurance company.
      
      
   5. If you don't need the money for medical expenses, you can take it out at any time, to spend on anything.  You pay the tax when you withdraw it for non-medical expenses, plus a 10% penalty.
      
      
   6. You can take money out to spend on anything after age 65.  You pay the tax when you withdraw it for non-medical expenses (no penalty).
      
      
   7. You can put in additional "catch-up" amounts after age 55.  For HSAs, the amounts are:
      
      
      • 2005:  $600
      • 2006:  $700
      • 2007:  $800
      • 2008:  $900
      • 2009:  $1000
        
        
   8. You can roll over larger amounts from other similar plans.  For an HSA, this means you can roll over from other HSA plans, or from Archer MSA plans (but not from IRAs, HRAs or FSAs, except for the two once-in-a-lifetime options described below).
      
      
   9. You can put the money in any time before April 15 of the next year.  Therefore, you can put all of the money in Jan 1 (to start growing tax-deferred ASAP), or all of it Apr 15 of the next year (after you know how much your actual medical expenses for the year were, though you have to open the plan before incurring the expenses).  Or anything in between, in single or multiple deposits.
      
      
   10. When you die, your spouse can treat your HSA as if it had always been their own, with no change in tax status.
       
       
   11. When you die, your non-spouse beneficiary pays tax on the inherited balance.
       

   
   Unlike an IRA:

   1. You can take the money out tax-free at any time to pay medical expenses.  This is not just tax-deferred, like an IRA.  It is tax-free!
      
      This is true for medical expenses of you, your spouse, or any of your dependents, even if they weren't your spouse or dependent when you made the contributions.  Therefore, you can save for future medical expenses of future kids, or for your spouse before you get married, or for your parents or other people before they become your dependents.
      
      This is true even if you are no longer eligible to make contributions to an HSA at the time you make the withdrawal, because you have a low-deductible insurance plan (see discussion of high deductible insurance plans below), or are not insured, or whatever.  For example, you can make contributions while you are in any of the following situations:
      
      
      1. Can afford to have a high deductible (while young, healthy, etc.)
         
         
      2. Cannot afford the high premiums of a low deductible plan
         
         
      3. Do not yet have a better plan:
             - Not yet married to someone who has a better plan
             - Not yet working for a company with a better plan
             - etc.
         
         
      4. Can afford to pay insurance premiums.
         

      Later, you can withdraw the money to pay medical expenses when you are in the opposite situation:
      

      1. Are older, less healthy, etc.
         
         
      2. Can afford a high premiums of a low deductible plan, but want to pay even the low deductible expenses tax-free.
         
         
      3. Finally have a better plan:
             - Finally married to someone who has a better plan
             - Finally working for a company with a better plan
             - etc.
         
         
      4. Cannot afford to pay insurance premiums at all (if you are really broke).

      You keep the records personally about what the money was spent on.  You don't have to justify each expense to the bank as you make the withdrawal.  Just keep it honest, in case you get audited.
      
      

   2. You can set up a credit or debit card with your HSA and use that card to pay medical bills.
      
      
   3. Your employer can make the contributions for you, in which case it's tax-free to you (no federal tax, no FICA, etc.) like any other medical benefit.  I think if you take it out for other than medical expenses, it is only tax-deferred, just as though you'd put it in yourself, so you have to pay the taxes then, and the penalty if less than 65 years old.
      
      
   4. You can use the money tax-free (not just tax-deferred) to pay:
      
      
      1. Medical expenses as described above.
         
         
      2. Health insurance premiums while you are on unemployment.
         
         
      3. COBRA health insurance premiums (the kind you pay for up to 18 months to stay on your former employer's group plan after leaving or being fired, before finding another job).
         
         
      4. Long-term care insurance premiums.
         
         
      5. If over age 65:
         1. Premiums for Medicare Part A, Part B and Medicare HMO (but not Medigap policies).
         2. Employee share of premiums for employer-sponsored health insurance for employees and/or retired employees.
            
            
   5. You can have both an HSA and an IRA, each to its own dollar limit.
      
      
   6. There are two options for rolling money into an HSA from another tax-deferred account that is not an HSA or MSA.  Each of them can be done only once in a lifetime:
      
      
      1. You can do a once-in-a-lifetime "qualified HSA funding distribution" from an IRA into a HSA.  
         
         No taxes due since you are moving money from one tax-deferred account (IRA) to another (HSA).  However, since the money is gaining the new status of being tax-free if you spend it on medical expenses, you can't roll over your entire IRA.  The sum of the transfer amount plus any new money you deposit directly into the HSA that year is still subject to the annual limit.  So, you lose a chance to defer some income, and instead roll over some savings that is already tax deferred.  This is only useful if you can't afford to make a regular contribution that year.
         
         
      2. You can also do once-in-a-lifetime "qualified HSA distribution" from an FSA or HRA, with no taxes due.  No dollar limit, I think.  This makes sense since they seem to be weaning people off of these less useful arrangements (FSA and HRA) onto HSAs.
         

   
   Restrictions:  During the months that you are paying into the HSA account:

   1. You must not be covered by any additional health plan.
      
      
   2. You must not be eligible for Medicare (so you can't contribute past age 65).
      
      
   3. You must be covered by a "High Deductible Health Plan" (HDHP).  This means:
      
      
      1. Your insurance plan deductible must be at least:
         
         
         • 2005:  $1000 (individual) or $2000 (family)
         • 2006:  $1050 (individual) or $2100 (family)
         • 2007:  $1100 (individual) or $2200 (family)
         • 2008:  $1100 (individual) or $2200 (family) -- unchanged from 2007

         The point is to encourage people to have high deductibles, so they'll have an incentive to keep their own medical expenses down.

      2. Your max out-of-pocket expense (deductibles, co-pays, etc.) under the insurance plan must be no more than:
         
         
         • 2005:  $5100 (individual) or $10,200 (family)
         • 2006:  $5250 (individual) or $10,500 (family)
         • 2007:  $5500 (individual) or $11,000 (family)
         • 2008:  $5600 (individual) or $11,200 (family)

         The point is to limit how much money you can avoid paying tax on, and to rule out plans where you are not really insured at all because the max out-of-pocket is sky-high.

      3. Also, before 2007, you couldn't put away more than the amount of your deductible each year.  In 2007 and beyond, you can put away as much as the full legal limits, regardless of the amount of your deductible, as long as the deductible is high enough to qualify as an HDHP.  For example, in 2006, if you had a deductible of $1500, you could put away no more than $1500 tax deferred, not the full $2700.  However, in 2007, with the same deductible, you can put away the full $2850 tax deferred.  
         
         So, as of 2007, why would you want a deductible that was significantly above the $1100 minimum, since it means you risk having to pay more out of pocket expenses before your insurance kicks in?  In 2006, you might have raised your deductible well past the $1050 minimum to $2700 because it allowed you to put away $2700 tax deferred, instead of just $1050.  However, as of 2007, you could leave the deductible at $1100 and still put away the full $2850 tax deferred.  So, why take the risk of having to pay more out of pocket?  The only remaining reason is that your insurance premiums will probably be lower if you have a higher deductible.

   For more info see:

           http://www.treas.gov/offices/public-affairs/hsa/
           http://www.irs.gov/pub/irs-pdf/p969.pdf (HSA, MSA, FSA, HRA)
           http://www.irs.gov/pub/irs-pdf/i8889.pdf (Form 8889 instructions)
           http://www.irs.gov/pub/irs-pdf/f8889.pdf (Form 8889)
           http://www.opm.gov/hsa/ (Government Employee HSA plan)

   Thanks to Mark Zahour for pointing out the once-in-a-lifetime rollover options!

   --Fred

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