The Medicare Prescription Drug, Improvement and Modernization Act of 2003 created special savings accounts known as Health Savings Accounts (HSA). The new HSAs will allow those with high healthcare deductibles, regardless of age, to use pre-tax dollars to cover health care costs.
An HSA is similar to an individual retirement account, but is designed to provide for the qualified medical expenses of an individual rather than for retirement. Contributions you make to an HSA are tax deductible and any earnings grow tax-free. In addition, any distributions you take to pay for qualified medical expenses are also tax-free. However, if you take a distribution and do not use the distribution to pay for qualified medical expenses, you will be subject to tax on the distribution in addition to a 10% penalty on the distribution amount.
In order to be eligible to establish an HSA, you must satisfy several conditions. First, you must be covered under a high deductible health insurance plan (HDHP). In 2013, if the coverage is only for you, the plan must have an annual deductible of at least $1,250 and annual out-of-pocket expenses not exceeding $6,250. This includes deductibles, co-payments, and other amounts, but not premiums. If the coverage is for your family, the plan must have an annual deductible of at least $2,500 and annual out-of-pocket expenses not exceeding $12,500. Other than providing benefits for preventive care, the plan may not pay benefits until you or your family has incurred covered medical expenses in excess of the minimum annual deductible. In addition, you may not be claimed as a dependent on another person’s tax return.
Second, you may not be covered by any other health plan that is not a HDHP, including your spouse’s plan, your parent’s plan, or Medicare. However, you may still be covered under workers’ compensation laws; home and auto insurance; insurance for specified diseases or illness; insurance that pays a fixed amount per day of hospitalization, and insurance covering accidents, disability, dental care, vision care, or long-term care.
Medical expenses that qualify for payment through your HSA are those that would be deductible for tax purposes as medical expenses. These expenses may be for you, your spouse, or your dependents, but they cannot be covered by insurance. In addition, you cannot have your HSA pay your health insurance premiums because they are not qualified medical expenses. However, your HSA can pay for your qualified long-term care insurance, COBRA health care continuing coverage, and your spouse’s or dependent’s premiums for Medicare Part A or B coverage.
Once you reach Medicare eligibility age (65 under current law), HSA withdrawals that are not used for medical expenses will not be subject to the 10% premature withdrawal penalty tax. However, you will owe federal income tax and maybe state income tax, too. There is no 10% penalty tax on withdrawals after death or disability either. This makes the tax rules for withdrawals similar to a deductible IRA.
If your HSA still has a balance when you pass away, your surviving spouse can take over your account and treat it as his or her own HSA. Just make sure to name your spouse as the account beneficiary in the event of your death.
For 2013 the maximum deductible contribution you can make to your HSA is the lesser of your annual deductible under the HDHP or $3,250 for coverage for yourself. If the coverage is for your family, this amount increases to $6,450. If you are age 55 or older, you may contribute an additional $1,000 to your HSA.
Along with contributing for yourself or your family, your employer may contribute to your HSA and can pay the premiums for your HDHP on a deductible basis. The contributions made by your employer on your behalf are not taxable to you.
Right now there is no big hurry because—like an IRA—you will be allowed to make your HSA contribution as late as the tax filing due date for the next year. With this setup, you can contribute to the account after you know how much your annual medical expenses amounted to, although you might want to contribute more than that if it is tax deductible.
If you have any questions regarding HSAs, please contact Henssler Financial at 770-429-9166 or experts@henssler.com.
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