Note for Employers: Health Savings Accounts (HSAs) are becoming a more common part of average Americans’ lives. Paired with HSA-qualified health plans, they cover a growing number of Americans’ health care costs and play an important role in their future.
This post is one of several that will appear in the coming months to help your employees understand HSAs better and use them strategically. The posts are excerpts from “HSA Owner’s Manual, Second Edition” by Todd Berkley (published by Tate Publishing, 2015). Todd Berkley is Senior Vice President and Managing Director for BenefitWallet®, A Xerox Solution.
An important revolution is taking place in health care. The revolution is the Health Savings Account (HSA) program. Actually, it is two programs in one. First, there’s an HSA-qualified health plan, which includes a broad up-front deductible. An HSA-qualified plan provides comprehensive health coverage, but only after the policyholder pays the cost of services before reaching the dollar figure at which insurance begins to reimburse expenses.
Second, there’s a Health Savings Account, a tax-advantaged vehicle that allows eligible individuals to divert a portion of their income or assets from the taxable income stream and set the funds aside in an account from which they can reimburse eligible expenses tax-free and efficiently save for future health care expenses.
The two plans essentially work in unison. An individual cannot have an HSA account without enrolling in an HSA-qualified health plan (and meeting certain other eligibility criteria). An individual enrolled in an HSA-qualified health plan does not have to open and contribute to an HSA, but failure to do so results in a lost financial opportunity.
The HSA World
With a Health Savings Account, you are entering the world of finance and investments, of IRS regulations and tax savings, of interest rates, dividends, and fees.
This post will give you some basic information so that you’ll understand HSAs in their proper context. We’ll take a deeper dive into these topics in later posts.
HSAs are offered by trustees or custodians – they perform the same duties in managing HSAs so we refer to them collectively as “trustees.”
An HSA is a tax-advantaged account designed to save and pay for certain health-related expenses tax-free. In practical terms, an HSA is a checking account with three distinct tax advantages:
- On deposits (contributions)
- On account balance growth, and
- Qualified withdrawals (distributions).
It may also include investment options for long-term saving.
Contributions to an HSA are tax-free or tax-deductible. The money that you deposit into your HSA, up to certain annual limits, is not included in your taxable income for that year. This provision allows you to defer a portion of your compensation dollar that otherwise would be taxed and diverting the full $1 to your HSA.
Account balances do not expire and grow tax-deferred. Funds that you do not use in a particular year are available for your use in future years (some refer to this as “rolling over” into a new year). And as your account grows with interest and perhaps investment gains, you defer taxes on any earning on that account growth at least until you withdraw the money.
Withdrawals from your HSA are tax-free if used for an eligible expense. You can make tax-free withdrawals (the IRS refers to them as “distributions”) for qualified medical, dental, and vision expenses, as well as over-the-counter supplies and equipment, over-the-counter drugs and medicine with a valid prescription, and certain insurance premiums. When you make distributions for eligible expenses, your account growth (on which taxes are deferred) is tax-free as well.
You may withdraw money for purposes that are not IRS-eligible. In this case, your contributions remain tax-free in the year they were made, your account growth remains tax-deferred, but you must include your distribution as taxable income in the year withdrawn and pay a 20% penalty, if applicable. While HSAs are designed to reimburse eligible expenses, you have the ability to make withdrawals for any purpose at any time. Your HSA trustee cannot draft a trust agreement that restricts your right to make distributions for any expenses. If your distribution is not for an eligible expense, you must include the amount of the distribution as taxable income in that tax year. In addition, if you are under sixty-five and not disabled, you pay a 20% penalty on your total distribution for non-eligible expenses.
An HSA is a trust agreement. That simply means that the account itself is subject to certain state laws that govern trusts. This legal distinction does not change the fact that it is your money in the account and that you are responsible for managing the account in compliance with federal tax rules.
You must work with an HSA trustee. You cannot merely designate a personal checking account as your HSA. An HSA is a trust, and you must work with trustee who manages the account in accordance with IRS guidelines and regulations. You may choose your own trustee, even if your employer or health plan directs funds to a trustee of their choice.
HSA trustees must be approved by the IRS. Trustees are usually banks, investment companies (such as brokerages and mutual fund companies), and insurance companies. Banks and credit unions are automatically approved as HSA trustees. Non-bank trustees must meet the same criteria as IRS trustees by demonstrating to the IRS that they are qualified fiduciaries, can account for transaction accurately, and understand HSA rules.
An HSA is an individual account. As with an IRA, a single person owns an HSA. There is no “Addams Family HSA” or “Brady Bunch HSA.” HSAs are accounts owned by an individual who is solely responsible for the account. Note: Your HSA trustee may allow you to designate other people who can draw on your HSA balances and one person’s HSA may be used for the family contribution limit in most cases.
You can own more than one HSA. In fact, you can own as many as you wish. And when you are pursuing specific financial strategies, a second HSA might make sense. For most people, one HSA alone provides all the benefits that an HSA program offers without the burden and cost of managing multiple accounts.
The author is not a lawyer and this article does not constitute legal advice. For more detailed information, consult the HSA Owners’ Manual by Todd Berkley.