A Health Savings Account may help you save on taxes while socking away money for medical expenses, but it’s not the right bandage for every family’s budget.
First off, you have to be eligible. We’ll explain what that means in a minute. If you are eligible, there’s still time to apply an HSA’s therapeutic deduction to your 2014 tax return as well as setting yourself up for 2015.
Here’s how it works: Money you contribute to your HSA established at a bank or brokerage goes in tax-free, earns interest tax-free and may be withdrawn tax-free anytime if you use it for medical expenses — kids’ braces now or even Medicare premiums after retirement.
That could mean up to a 30 percent savings in taxes on the contributions, says Wells Fargo.
Once established, the account is yours and goes with you when you change jobs. In some ways, it’s like a 401(k) or IRA for medical bills; it also has characteristics of a Flexible Spending Account (FSA), but without the use-it-or-lose-it gamble.
HSAs and high-deductible health insurance plans were launched in 2004 to help control health care costs, says the Mayo Clinic in Rochester, Minnesota.
“The idea is that people will spend their health care dollars more wisely if they’re using their own money. In addition, doctors and other health care providers will have an incentive to lower their rates because they’re competing for business,” Mayo says.
Are you eligible?
Only a worker younger than 65 with a qualifying “high-deductible health plan” (HDHP) and no other health insurance to draw on may establish an HSA, says the Treasury Department. If you’re older than 65, you can draw on your existing HSA, but you’ll pay a penalty if you contribute to it while on Medicare.
By the numbers
For 2015, the HDHP’s annual deductible must be at least $1,300 for individuals and $2,600 for families. Its out-of-pocket maximum cannot be more than $6,450 for individuals and $12,900 for families. Your maximum contribution to the account is $3,350 for an individual, $6,650 for a family.
For 2014, the deductible was $1,250 for individuals, $2,500 for families; out-of-pocket maximums were $6,350 individual, $12,700 families. You have until tax filing deadline of April 15 to establish an HSA and contribute up to $3,300 for an individual or $6,650 for a family and reflect a reduction in salary on your income tax return. (If you had a qualifying plan for only part of the year, your contribution limit will be lower.)
For either year, catch-up contributions of $1,000 are available for those age 55 and older.
About 21 percent of workers are covered by high-deductible health plans, according to the Bureau of Labor Statistics. Employees at the nation’s smallest firms, with one to 100 workers, are more than twice as likely to be covered by high-deductible health plans those in the largest companies, with more than 100 workers, the BLS estimates.Employers and others say they like HSA-qualified HDHPs because they “can bring both consumer choice and flexibility back into health care by increasing incentives for consumers to compare costs and demand better value,” says Dr. Stephen D. Neeleman in The Complete HSA Guidebook, published by HealthEquity, Inc., a publicly traded non-bank custodian of HSAs.
Interest in HSAs on the rise
More people are pumping up their HSAs.
HSAs grew to an estimated $22.8 billion in assets and almost 11.8 million accounts as of June 30, 2014, according to the latest semi-annual survey by Minneapolis-based Devenir, an HSA investment firm. That is a 26 percent growth in HSA assets and 29 percent boost in the number of accounts compared with a year earlier.
A separate survey by the nonpartisan Employee Benefit Research Institute (EBRI) reveals people younger than 25 had an average of $697 in their HSA at the end of 2013, compared with $3,780 among those ages 55 to 64. People 65 and older averaged $4,460 balances, EBRI said.
The average annual amounts withdrawn for claims also increased with age, EBRI says. People younger than 25 had an average annual distribution of $667, compared with $2,335 among those 55 to 64 and $2,017 for those 65 and older.
A little caution
If you think you might need expensive medical care in the next year and would find it hard to meet a high deductible, an HSA might not be your best option, the Mayo Clinic says. Information about the cost and quality of medical care can be difficult to find, it warns.
Withdrawing money from your HSA for non-medical expenses before you turn 65 will trigger taxes on the money plus a 20 percent penalty, the IRS warns. After age 65, the penalty goes away, but you must still pay taxes on the withdrawals.
You must keep records of medical spending, such as for doctors and prescription drugs but not for over-the-counter aspirin, for example, and report distributions from your HSA, the IRS says.
While money paid by your employer into an HSA reduces your income and likely your current tax liability, the contribution dings your Social Security earnings record, which in turn could bleed some cash from your monthly benefit when you retire. But that future reduction may be more than offset by the tax savings. You can use Social Security’s online calculators to see how your situation would be affected.
“As an HSA owner you’ll likely do better than break even each year if you are in good health,” says Patricia Q. Brennan, a certified financial planner and senior extension trainer at Rutgers New Jersey Agricultural Experiment Station. “With the savings on your insurance premiums, you should be able to accumulate a sizable nest egg.”
For more tips on the advantages of a HDHP and how to maximize those benefits, check out this video. Let us know how you are managing your health care costs in the comments below or on Money Talks News Facebook page.