7 Things You Need to Know About Health Savings Accounts

We all know the saying about death and taxes. And if you managed to avoid the former this year, no doubt, you didn’t avoid the latter. (And you thought there was nothing to look forward to after the holidays!)

If you’ve been fretting about the big bite Uncle Sam is taking out of your household income—especially in light of the rising costs of living in general and healthcare in particular—take a deep, calming breath. Personal finance expert Eric Tyson has three words for you: Health Savings Accounts. You may not know much about them, but it’s time you learned.

“Like IRAs, Health Savings Accounts represent a great way for you to put away money for a rainy day and reduce your taxes,” says Tyson, coauthor along with Margaret Atkins Munro and David J. Silverman of Taxes 2008 For Dummies®.

HSAs offer relief for people whose traditional health insurance premiums keep rising and rising, with no end in sight. They provide an always welcome tax break and they enable people to be more in control of their healthcare.

If you are unfamiliar with how HSAs work, here are the basics: The purpose of these accounts is to allow you to save, on a tax-free basis, toward current or future unreimbursed medical expenses. If you’re covered by a qualified high-deductible health plan with annual deductibles of at least $1,100 for individuals and $2,200 for families for 2007, you may be eligible to establish an HSA. If you get sick and haven’t met your deductible, the funds in your HSA can be used to pay it off. Once your deductible is paid, your insurance plan will kick in and cover any subsequent medical costs under your policy, but your HSA can still be used to pay for your co-pays and any noncovered healthcare expenses.

Like IRAs, an HSA can be invested in most types of securities (typically mutual funds) and allowed to grow tax-free until you need to access the money to pay for qualified medical expenses (medical insurance premiums are excluded). Payouts for qualified medical expenses are tax-free. You may contribute to the account until you enroll in Medicare. At that point, contributions are no longer allowed, but you may continue to take money from the account.

If these tax-deductible accounts have sparked your interest, read on to find out more about HSAs:

1 HSAs help you keep thousands of dollars away from Uncle Sam every year. For 2008 your family can deposit a maximum of $5,650 into an HSA—or if you’re single the limit is $2,850.

You can make your own deposits into the account or your employer can do so. For an immediate tax deduction, you can now do a one-time transfer of funds from an employer’s health reimbursement account or a health flexible spending account.

“Another easy way to contribute to your HSA is to have your tax refund money deposited directly into your account,” says Tyson. “If you normally have your refund deposited to your IRA, but would like to deposit some of the money into your HSA, you can now choose to have your refund split between as many as three accounts. There are all kinds of ways to contribute to HSAs, and it’s important that potential account users understand the possibilities.”

2 An HSA is not a “get-out-of premiums- free” card. It won’t free you from the pain of having to pay a monthly premium, but it can lessen that pain. That’s because the high-deductible policies required for HSAs have much lower premiums when compared to those of traditional insurance.

3 HSAs are better than Flexible Spending Accounts because “use it or lose it” does not apply. If you are currently taking advantage of a Flexible Spending Account offered by your employer, then you know that one of the drawbacks of those accounts is that you either use the money in your account during your coverage period or it is forfeited back to your employer.  This is not the case with HSAs.  Your money can continue to grow from year to year until you need to use it. 

4 You may have to pay state taxes. “Because nothing is ever simple when it comes to taxes, the treatment of HSAs on a state level can vary,” says Tyson. “Certain states follow the federal tax laws for HSAs, others haven’t decided what they’re going to do, and still others reserve the right to tax interest or dividends you’ve earned in your HSA. You’ll want to know how your state operates before you set up an account. Ask your tax advisor or do some research online to find out.” 

5 In general, HSA money and IRA money must stay separate.  You may be wondering how your other funds [an IRA or a 401(k)] relate to an HSA. If unused, can the money in your HSA be rolled into one of your other retirement accounts? Or if you experience unexpected health costs and your HSA and insurance won’t cover all of them, can money from a retirement account be rolled into your HSA? 

The answers: no and maybe. Your HSA funds can never be rolled into one of your retirement accounts, and usually that’s true if the scenario is reversed. However, because of a provision in the Tax Relief and Health Care Act of 2006, IRA assets can be used to fund one year’s maximum HSA contribution, but it can happen only one time. 

“Some people might enter into  an HSA thinking if they don’t like  it or feel it’s not for them they can  just roll that money elsewhere,”  says Tyson. “That’s not the case, and understanding that fact is vital before opening up an HSA.” 

6 HSAs put you in control.  (Just keep good records!) One of the great things about an HSA is that you don’t have to have approval from anyone or any entity before you use money in the account. There is no pre-approval process as there is with some medical procedures being covered by insurance. There is no threat of being told your medical expenses simply won’t be covered as insurance companies are apt to do.  But remember to keep documentation of all of your medical expenses, or the IRS might tax your withdrawal. 

“Another great aspect of an HSA is that those funds can be used to cover those expenses that wouldn’t be or aren’t covered by your insurance,” says Tyson. “Things like your dental or vision care, including eyeglasses or hearing aids, can all be paid for using your HSA account. And when you show the proper documentation for them, the expenses will be tax-free.” 

7 HSAs could play a major role in reining in America’s out-of control healthcare costs. “With HSAs, people tend to hold themselves accountable for their healthcare choices because they think of it as their money rather than the insurance company’s,” says Tyson. “They go to the doctor less and shop for the most affordable options. That’s why many proponents see HSAs as a crucial factor in efforts to get a handle on the skyrocketing costs in America’s healthcare system.” 

Tyson concludes that if more people used HSAs and started being more careful about when and where they seek medical care, healthcare costs could potentially decrease across the board. 

“With health insurance premiums continuing to climb, HSAs and the high-deductible policies that they supplement are going to become increasingly popular,” predicts Tyson. “And some will benefit more than others.” 

The rules for these accounts are fairly intricate, so if you qualify for an HSA, do your homework. And if you decide an HSA isn’t right for you, don’t worry; there are still plenty of good options to reduce your tax bill for 2008.