If you have a high-deductible health plan -- and an increasing number of Americans do -- it may be time to open a Health Savings Account. It lets you save on your income taxes because contributions to an HSA are deductible, just like contributions to Individual Retirement Accounts.
But, unlike IRAs, you don't have to wait for years to get your money out of an HSA. You can tap it to pay for medical expenses on a tax-free basis with no time limit.
"If you paid qualifying expenses, you can reimburse yourself anytime," said Jennifer Harris, marketing and communications director at HealthSavings Administrators. "If you had expenses in 2015, but you needed the money in 2017, you can reimburse yourself then. It's very flexible."
How does an HSA work?
HSAs are savings accounts that are paired with high-deductible health plans. The idea was to encourage consumers to take greater control of their medical expenses by having them pay more of the costs directly. But of course, that raised the specter of having insurance that was too costly to use. So, the government provided those with a high-deductible plan the ability to pair it with a tax-free savings account.
Presumably, this allows consumers to budget -- setting aside money on a monthly basis -- to pay either current or future medical bills when those bills are otherwise unaffordable. Thus, to save through an HSA, you must also have a qualifying high-deductible health plan.
What is that?
It's simply a health insurance plan that meets certain government requirements and has a minimum deductible in 2016 of $1,300 for single coverage or $2,600 for family coverage. The insurance policy must also limit consumers' annual out-of-pocket cost to no more than $6,550 annually for single coverage or $13,100 for family coverage, said Jody Dietel, chief compliance officer for WageWorks, a San Mateo company that administers benefit plans.
If you have such a plan, you can contribute up to $3,350 as an individual or $6,750 per family per year to a tax-deductible HSA. If you're over age 55, the contribution limits are even higher -- $4,350 for an individual and $7,750 per family.
What does that get you?
If you're in the 28 percent federal income tax bracket, making the maximum family contribution of $7,750 would save you $2,170 in federal income taxes and is likely to cut your state tax bill, too.
How do you tap money in the account?
Participants usually get debit cards -- just like you'd get for a normal bank account. That card can be used at your doctor's office or pharmacy to pay eligible expenses. If a health provider doesn't accept your debit card, you can pay the bill with a check or credit card and then have the HSA administrator reimburse you later.
What are eligible expenses?
The list of eligible expenses is long. You can use money in the accounts to pay deductibles and co-payments, but also for acne or alcohol treatments, braces, birth control or even to pay for breast-feeding classes, drug treatment and contact lenses. You can use an HSA to pay for almost any expense that's medically necessary.
The accounts can't be used for cosmetic procedures, such as trimming the size of your nose. However, if you had surgery to fix a deviated septum and it just happened to make your nose more attractive, that's allowable. For a full list and explanation of what HSA dollars can be spent on, Wage Works offers a handy guide.
Do you lose the money if you don't spend it?
No. Unlike so-called "flexible spending arrangements," there's no deadline to spend HSA funds. You can tap the account for immediate bills or leave the money saved and invested indefinitely.
Dietel said she pays her medical expenses out of pocket each year and leaves her HSA contributions to accumulate. Her plan is to use this money in retirement to pay for long-term care costs or just to supplement her retirement savings. Of course, if she had a catastrophic illness between now and then, she could tap the savings to pay for that instead.
Are there fees to open or maintain the accounts?
Yes. Just like opening a bank account, you're likely to pay some fee to maintain an HSA. HeathSavings Administrators charges a $45 annual fee for a simple HSA savings account, which is invested in bank deposits and pays a modest amount of interest.
The firm also gives customers the ability to invest their HSA savings in mutual funds offered by Vanguard and Dimensional Advisors. It charges another small service fee for that -- roughly $2.50 per year per $1,000 invested. Money invested in mutual funds is also subject to management fees charged by the mutual fund company. However, both Vanguard and Dimensional are noted for their low-cost approach.
In addition, most providers will have a schedule of other fees for things like overdrawing the account or replacing your debit card -- just like a bank. Be sure to check with your HSA provider to get a full list of fees and under what circumstances they're imposed.