What is a Health Savings Account (HSA)?

Even if you are the type of person who never gets sick, you probably have some occasional expenses related to your health—like dental cleanings, contact lenses or band-aids. Wouldn’t it be great to be able to pay for them with tax-deductible money? The tax deduction means that for every $100 you put towards health expenses, you might get $10 to $50 of it back at tax time. (The amount depends on your specific tax situation.) If you’re planning to spend thousands of dollars on something like laser eye surgery; or tens of thousands on fertility treatment, that financial benefit can really add up. One way to tap in: get a Health Savings Account (an HSA).

What is a Health Savings Account (an HSA)?

A Health Savings Account is an account into which you can deposit up to $3,350 per year for individuals and $6,750 for families (in 2016). You can use this money for eligible health expenses any time—20 days or 20 years after you put it in the account. If you never need it for health expenses, or have a balance when you retire, you can withdraw it as income in retirement.

You can deduct the contributions from your income in the year that you put them in the account. This allows you to avoid federal income tax on the money (and state income tax, except in Alabama, California and New Jersey, because these states tax the contributions). If your HSA is set up in conjunction with an employer-sponsored health insurance plan, the contributions may even come out of your paycheck pre-tax and get deposited automatically into your account.

Eligible individuals can open an HSA at any bank, credit union or investment institution that offers them. Typically, you open the account, deposit the money, and get a debit card which you can use to pay qualified health expenses. You might also be able to use a checkbook connected to the account, or to pay your expenses using other means and get reimbursed with funds from your HSA.

Who is eligible for a Health Savings Account (an HSA)?

To establish and/or fund an HSA, you must be enrolled in a specific type of high-deductible health plan (HDHP). Its terms must fall within the following limits:

HDHP Minimum Deductible Amount $1,300 $2,600
HDHP Maximum Out-of-Pocket Amount $6,550 $13,100

An eligible HDHP plan must also meet another IRS requirement: “Except for preventive care, [an HDHP plan] may not provide benefits for any year until the deductible for that year is met.” 

That means that a slightly more generous high-deductible plan, which pays for any portion of things like prescription drugs or specialist visits or an X-ray before the deductible is met is not HSA-eligible. For example, if your plan covers specialist visits with a $50 copay, before the deductible is met, it’s not HSA-eligible, even if it meets all the other requirements. If it covers a portion of a prescription before you meet your deductible, it’s not eligible. 

To be eligible for an HSA, you must also have no other health insurance plan, with certain exceptions such as coverage for dental care, vision care, accidents, disability or long-term care. You cannot be enrolled in Medicare. And you cannot be claimed as a dependent on someone else's tax return. 

What can you use a Health Savings Account (an HSA) for?

You can use the money in an HSA to pay for many medical, dental, vision or hearing-related expenses. These include anything that qualifies as a tax-deductible medical or dental expense (with the exception of over-the-counter medications and health insurance premiums, unless you're between jobs).

Eligible expenses include typical out-of-pocket expenses such as your health insurance deductible, co-pays for prescriptions and doctor visits and co-insurance for medical care. However, they also include many surprising expenses that your health insurance plan might never cover in the first place, like the following (please consult irs.gov for an exhaustive list, and exclusions):

HSA-Eligible Costs
Acupuncture Eye surgery, including laser eye surgery for defective vision
Alcoholism treatment (including transportation to AA meetings) Fertility treatments
Artificial teeth (and limbs) Guide dogs, and other service animals
Bandages Hearing aids
Braille books and magazines Lead-based paint removal
Capital expenses for home alterations to address medical conditions (like installing ramps) Pregnancy tests
Chiropractor Psychoanalysis
Contact lenses, and solutions and cleaners for them Transportation and lodging essential for medical care
Dental treatment (but not teeth whitening) Weight-loss programs (see details)
Eye exam Wheelchair
Eyeglasses Wig (if hair is lost due to disease)

Since some of these expenses can be planned in advance—like laser eye surgery, fertility treatments, and lead-paint removal—using an HSA could help you save a considerable amount of money on them.

It's important to note that you can only use HSA money for expenses incurred after the account was established.

How an HSA Can Save You Money

Whenever you pay for anything—a meal, a sweater, an insurance deductible—with after-tax money, you generally need to earn much more than the sticker price to pay income taxes and then use the remaining money for the expense. The following table shows how much you can save by using HSA funds for $3,000 worth of eligible health expenses.

Depending on your income and your state, here are a few examples of how much an individual with an adjusted gross income of $50,000 would save by paying for $3,000 worth of medical expenses using an HSA.

Where You LiveYour Total Tax Rate*Earn This to Pay without an HSAEarn THIS to Pay with an HSA**TAX Savings Due to HSA
California (HSA contribution not deductible from state taxes) 36.95% $4,758 $3,409 $1,349
Illinois 36.40% $4,716 $3,248 $1,468
New York City 41.55% $5,133 $3,248 $1,885
Florida 32.65% $4,454 $3,248 $1,206
Texas 32.65% $4,454 $3,248 $1,206

* Includes Social Security and Medicare taxes, federal income taxes and state taxes if applicable.

** Everyone pays 7.65% in Social Security and Medicare taxes, up to certain income limits, unless the HSA is offered through an employer cafeteria plan. The above table assumes the HSA is individually established by someone who is not self-employed.

While almost all HSA-eligible expenses are deductible even without an HSA if you itemize your taxes—the deduction is less generous and more complicated. You would only be able to deduct the amount that exceeds 10% of your income (AGI), for example. Your deductions also need to be more than your standard deduction to be worth taking. With the HSA, you don't need to meet these criteria; you'll just have to check the other requirements above.

For example, if you have an annual income (AGI) of $50,000, you would only be able to deduct the health expenses that exceed $5,000 (assuming you have deductions, like mortgage interest) to push your total Schedule A deductions above the standard deduction). With the HSA-approach, the first $5,000 you pay would also have been deducted (assuming you have that much in your HSA).

Any money that remains in your HSA can be invested, and withdrawn after age 65 as retirement income, completely tax-free. This is a huge benefit for those lucky enough to stay healthy so long.

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