How Does a Health Savings Account (HSA) Work?
Offset Health Care Costs With an HSA
Health Savings Accounts (HSAs) are designed to help individuals offset the health care costs associated with High Deductible Health Plans (HDHPs).
An HSA is defined as “a tax-exempt trust or custodial account you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur.”
You must be an “eligible individual” to qualify for an HSA. Even if you are married and both spouses qualify, you must set up separate HSAs – you cannot have a joint HSA.
You must set up an HSA with a trustee. Qualified trustees include banks, insurance companies, and anyone already approved by the IRS to be a trustee of IRAs or Archer MSAs.
The Benefits of a Health Savings Account (HSA)
These are a number of potential benefits to having an HSA:
• You can claim a tax deduction for contributions that you (or someone other than your employer) make to your HSA, even if you do not itemize your deductions on Form 1040.
• HSA contributions made by your employer may be excluded from your gross income.
• HSA contributions stay in your account until you use them.
• The interest (or other earnings) on the assets in your account are tax-free.
• HSA distributions may be tax-free if you used the funds to pay for qualified medical expenses.
• An HSA is “portable,” so it stays with you even if you change jobs, become unemployed, or retire.
Who Is Eligible for an HSA?
To qualify for an HSA, eligible individuals must meet the following requirements:
• 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” (see below).
• You are not enrolled in Medicare.
• You cannot be claimed as a dependent on another person’s income tax return.
NOTE: If you are married, you may still be eligible for an HSA even if your spouse has non-HDHP coverage, provided you are not covered by your spouse’s plan.
Other Health Coverage
To qualify for an HSA, you generally cannot have any other health coverage that is not an HDHP. However, you are allowed to have additional insurance/coverage that applies only to certain items (such as liabilities incurred under workers’ compensation laws). For more information, see Page 4 of IRS Publication 969 (Health Savings Accounts and Other Tax-Favored Health Plans).
Any eligible individual can make contributions to an HSA. If an employee has an HSA, both the employee and their employer may contribute in the same year. If a self-employed or unemployed individual has an HSA, the individual can make contributions. Additionally, family members or other persons can make HSA contributions on behalf of an eligible individual.
HSA contributions must be made in cash – contributions cannot be in the form of property or stock. (However, a rollover contribution does not need to be in cash. Rollover contributions may come from Archer MSAs or other HSA, but are not included in your income and do not reduce your contribution limit. You do not need to be an “eligible individual” to make a rollover contribution from your existing HSA into a new HSA. Although the rollover must occur within 60 days of the date of receipt, and you are only allowed to make 1 rollover contribution to an HSA during a 1-year period.)
HSA Contribution Limits
The amount that can be contributed to your HSA depends on a few factors – including your age, the type of HDHP coverage you have, the date you become an eligible individual, and the date you cease to be an eligible individual.
You can make HSA contributions for 2014 up until April 15, 2015. For 2014, the HSA contribution limit is $3,300 for individuals who have self-only HDHP coverage. Those who have family HDHP coverage can contribute up to $6,550.
For 2015, the contribution limit is $3,350 if you have self-only HDHP coverage. If you have family HDHP coverage, you can contribute up to $6,650.
Excess contributions are generally subject to a 6% excise tax, but you may be able to deduct them in a later year. For more information, see Form 5329 (Additional Taxes on Qualified Plans and Other Tax-Favored Accounts).
The Last-Month Rule
You are considered to be an “eligible individual” for the entire year if you are an eligible individual on the 1st day of the last month of your tax year (December 1st for most people). For example, if you had family HDHP coverage on December 1, 2014, your contribution limit for 2014 is $6,550 even if you changed coverage during the year.
Form 8889: Health Savings Accounts (HSAs)
Use Form 8889 (Health Savings Accounts) to report your HSA contributions, including contributions made on your behalf and by your employer. Make sure to file Form 8889 with your 1040 tax return.
A distribution is basically money that you get from your HSA. After you establish the HSA, you can receive tax-free distributions to pay (or be reimbursed) for qualified medical expenses. However, any expenses that you incur before your HSA is established will not qualify.
“Qualified medical expenses” are generally the same as the expenses that qualify for the Medical Expenses Tax Deduction. Qualified medical expenses may be incurred by you, your spouse, or your dependents. For details, see IRS Publication 502 (Medical and Dental Expenses).
For more information about HSAs, including contributions and distributions, refer to IRS Publication 969 (Health Savings Accounts and Other Tax-Favored Health Plans).