Concerned about the high cost of healthcare? Worried that your
insurance doesn’t cover all your costs? Fortunately, a partial solution
may be just around the corner. Since January 2004, taxpayers have had a
tax savings tool called Health Savings Accounts, or HSAs. These HSAs
may solve many of your healthcare cost problems.
How an HSA Works
In a nutshell, HSAs work like this. You buy a specific type of major
medical, or catastrophic coverage, insurance called a High Deductible
Health Plan. (This special HSA-compatible insurance is also known by
the acronym HDHP.) Then, you annually contribute up to roughly $5,100
for a family and up to $2,600 for an individual--to a special health
savings account. (Note that slightly higher deductions are available to
taxpayers over the age of 55. Also, annual deductions are indexed for
inflation.)
How You Save Taxes with HSAs
HSAs work because you get a tax deduction for the money you contribute
to the health savings account. However, as long you spend the money in
the account for eligible healthcare expenses—pretty much anything
reasonable—you aren't taxed when you withdraw the money. Note that HSAs
deductions are not limited by taxpayer incomes.
In effect, the HSA makes all or most of your uncovered healthcare
expenses fully deductible. This is a big deal because for most people,
healthcare expenses are not deductible.
Just to put the value of an HSA into perspective, a family can save
from $500 to as much as $1750 annually in income taxes by using one of
these accounts. The final savings, predictably, depend on family income
and the state where the family lives.
One other thing. Don’t confuse HSAs with the old style Flexible
Spending Accounts, or FSAs. With FSAs, you lost the money you didn’t
spend by the end of the year. With HSAs, you don’t lose the money. The
unused balance just carries forward to the next year.
Aren’t Medical Expenses a Tax Deduction Anyway?
No, not really. For most people medical expenses are not a tax
deduction. Here’s why. Healthcare expenses do count as an itemized
deduction for people who don’t use the standard deduction. However,
only the portions of one’s healthcare costs that exceed 7.5% of
adjusted gross income get deducted. That means that most people never
get to use their healthcare costs as tax deductions because their
healthcare costs don’t cross the 7.5% threshold.
Another Benefit: HSAs May Also Save Premiums
HSAs sometimes produce another economic benefit. The HDHP insurance
itself may save people money because they buy less insurance. This is
especially true for people who aren’t already using major medical
insurance.
How to Set Up a Health Savings Account
HSA accounts aren't difficult to set up. Essentially, you do just two
things. (1) Get medical insurance that qualifies as an HDHP, and (2)
Open an HSA account with a bank that offers HSAs. Your current medical
insurance provider is a good place to start your search for HDHP
insurance. You can also check with your state’s Blue Cross or Blue
Shield insurer.
Three Warnings about HSAs
For what it's worth, I am now using an HSA myself. (I got my HDHP from
Premera Blue Cross and use an HSA account from HSA Bank.) But let me
also share three caveats: First, obviously, you never want to cancel
one insurance policy until you're sure you have a replacement policy.
Second, you do need to be careful about the fees associated with the
HSA "bank account," so shop around. Third, if you withdraw money from
an HSA for something other than a valid medical expense, the withdrawal
is taxable and subject to a 10% penalty.
