What is a Health Savings Account (HSA)?

Health Savings Accounts have grown in popularity over the last several years, and my guess is that they’ll only continue to grow with the new health-care legislation on tap.

So what exactly is a Health Savings Account or HSA, and how would it benefit you? That’s what we want to try to answer today:

What is an HSA?

An HSA is simply a tax-advantaged medical savings plan for those in a qualified high deductible health insurance plan. Folks with a high-deductible health plan are able to contribute money into an account without paying taxes on the deposits.

In many cases, employers will have an HSA available for employees to contribute to, and may also make contributions on behalf of the employees as well. Once the funds are in the account, owners can take the money out for medical expenses.

Whatever funds have not been used for qualified medical expenses can roll over from year to year to continue to accumulate – again, tax deferred.

Funds can be used completely tax free for certain medical expenses as defined by the IRS. If you receive any distributions for other reasons besides medical expenses, that withdrawal will be subject to ordinary income tax and possibly an additional 10% penalty, which is similar to an early IRA withdrawal.

Think of a Health Savings Account as Traditional IRA meets Roth IRA, but is used for medical expenses. So, tax-free in, tax-free out (provided you meet certain qualifications of course).

That’s a pretty decent deal, so long as you can afford a high-deductible plan and can fund an HSA. Remember, with a high-deductible health insurance plan, you’re on the hook for a lot of medical expenses up front, but you can use your HSA for those expenses.

Benefits of an HSA

Here are the main benefits of the HSA according to the IRS website:

  • You can claim a tax deduction for contributions you, or someone other than your employer, make to your HSA even if you do not itemize your deductions on Form 1040.
  • Contributions to your HSA made by your employer (including contributions made through a cafeteria plan) may be excluded from your gross income.The contributions remain in your account from year to year until you use them.
  • The interest or other earnings on the assets in the account are tax free.
  • Distributions may be tax free if you pay qualified medical expenses.
  • An HSA is “portable” so it stays with you if you change employers or leave the work force.

A couple of notable things here. I love that you can write off the contributions even if you do not itemize, and the fact that these are portable is a great thing.

Your contributions roll over from year to year, and your interest is tax free! All of these things make an HSA an attractive alternative to a regular medical plan.

Changes in 2011

Previously, you could use your HSA for over-the-counter medications like aspirin, cough syrup etc. Over the counter medications are no longer considered Qualified Medical Expenses in 2011.

This was one thing that I loved about the HSA. Any time you had to run out to the drug store, you could use the HSA tax free! Not any more.

HSA Contribution Limits for 2011

Contributions are limited on an annual basis, and are the same for both 2010 and 2011.

If you are a single taxpayer, you can contribute up to $3,050. If you are married, your family can contribute up to $6,150. If you are over age 55, you can contribute an extra $1,000 whether you are a family or single.

Is It Right For You?

Of course, the answer is – “It depends”. It’s not right for everyone, but certainly, for some folks, this is a great deal, and can help them save money. If you’re curious whether an HSA makes sense for you, you can check out this handy HSA calculator.

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  1. Great summary Jason. The over the counter items aren’t allowed for our Flex plan either – which is pretty annoying. You need a doctor’s prescription to purchase Tylenol with the flex card… raising the cost from $4 to $44 for that bottle of Tylenol.

    Can’t complain too much though, the other HSA benefits are pretty nice.

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