Those who do not have access to any type of group health coverage, COBRA or Medicare have another option available to them that can help to defray the rising costs of healthcare. Health Savings Accounts were introduced in 2003 as a type of medical savings account for unemployed and self-employed taxpayers. Although these accounts are similar to Flexible Savings Accounts, they are stand-alone entities and cannot be used in conjunction with any type of group health insurance. Health Savings Accounts provide perhaps the most efficient form of savings for medical expenses that is available in the United States tax code. First, all contributions that are made into these accounts can be written off as above-the-line deductions, which means that the taxpayer does not have to itemize in order to qualify for this deduction. Second, any funds withdrawn to pay for qualified medical expenses are exempt from taxation, similar to distributions taken from a Roth IRA. Finally, one of the best features of these accounts is that any funds that are not used to pay for healthcare can eventually be withdrawn and used for retirement, provided that the accountholder is at least age 59 1/2 (premature withdrawals are subject to a 20% early withdrawal penalty). All distributions used for retirement are taxed as ordinary income.
For 2011, individuals are allowed to contribute up to $3,050 into an HSA while families can contribute up to $6,150. These numbers rise to $3,100 and $6,250 respectively for 2012. There is also an additional “catch-up” contribution of $1,000 available for those aged 55 and above.
Health Savings Accounts require that each account owner purchase a special type of health insurance policy known as a Qualified High Deductible Health Plan. These policies are specifically designed for HSAs and usually have deductibles of about $1,200 for individuals and $2,500 for families, with excellent catastrophic coverage above these limits. Since all monies that are not used to pay for medical purposes can be used as retirement income, this effectively lowers the amount of money that is lost in policy premiums and ultimately helps to resolve the dilemma faced by many account owners who struggle to save for retirement and pay for adequate health care at the same time.
The definition of qualifying medical expenses for Health Savings Accounts is quite broad. Tax-free distributions can be taken to pay for many types of expenses that are not typically covered by health insurance, such as dental insurance, medical devices such as walkers and hearing aids, eye exams and laser surgery, over-the-counter drugs and long-term care expenses. Although some types of expenses do not count toward the deductible for the Qualified High-Deductible Health Plan that must be purchased in conjunction with these plans, they still qualify for the tax advantages listed above.
Opening a Health Savings Account
There are many different custodians who offer HSAs, including banks, brokerage firms and other financial institutions. Each custodian offers a range of investment choices that account owners can purchase with their contributions. Many providers also charge fees to open and maintain HSAs, and account owners must fund their accounts by December 1 in order to deduct their contribution on their tax returns for that year. Most HSAs have debit card and check writing privileges, but the specific fees and services offered will differ by custodian. For more information on Health Savings Accounts, visit the IRS website at www.irs.gov or consult your financial advisor.