Why HSAs are all about savings
May 01, 2008
by Ken Hamil
Money magazine calls Health Savings Acounts (HSAs) the new health IRA because they combine two ideas in one: they act like an IRA in that the amount contributed to the account can reduce your taxable income; interest and earnings also accumulate tax free. But unlike an IRA, you can withdraw money from the account at any time for current and future qualified medical expenses, including deductibles and other out-of-pocket expenses. The premise behind an HSA: you manage the account yourself. Therefore, you have a financial incentive to shop for health care services in the same way you might before buying a car. You also have a reason to stay healthy.
With an HSA, the emphasis is on savings. Like a passbook account, unused funds may be carried over from one year to the next. You own it. The HSA goes with you whenever you retire or leave your employer.
Some Requirements
By law, an HSA must be paired with a high deductible health plan (HDHP) that does not offer first-dollar medical coverage other than for preventive care services. Typically, the HDHP is part of a network so you can take advantage of provider discounts. In 2006, the plan must have a minimum deductible of $1,050 for individuals and $2,100 for families. After you satisfy the deductible, the HDHP pays a percentage of your health care expenses; you pay the balance up to a flat dollar amount.
Eligibility
To be eligible, you must be under age 65 and not enrolled in Medicare. If someone else can claim you as a dependent on their tax return, that’s a no-no. Furthermore, you cannot have another medical plan in addition to the HDHP; disability, dental, vision and long-term care insurance are exceptions.
How it works
Once your HDHP is in place, deposits to your HSA can begin; anyone – you, your employer, a family member — can contribute to it. Like most retirement plans, there is a maximum contribution — You'll be able to make the rollover only once in your life, and the rollover amount is limited to the HSA maximum contribution for the year, minus any contributions you've already made. If you have an individual plan, for example, you can contribute only $2,850 to an HSA in 2007, which would also be the limit on the amount of money you could transfer from an IRA to an HSA. If you've already contributed $1,000 to the HSA this year, then you can roll over only $1,850 from the IRA.
Say your employer contributes $525 to your HSA and you contribute an equal amount, for a total of $1,050; this figure equals your annual deductible. Your doctor charges $100 to treat a strep throat. Later that year, you purchase medications totaling $400. So at the end of the year, you’ve withdrawn $500 from the account to cover qualified medical expenses; the balance of $550 will roll over to next year.
Premium savings
Because of the high deductible, the rates on an HDHP are considerably less than a conventional medical plan. Often you can save as much as 20 to 40 percent in premiums. These rates make HSAs attractive to businesses both large and small—as well as to the self-employed or uninsured.
Tax savings
Contributions tax-free
Because an employee’s contributions to an HSA are generally pre-tax, your taxable income goes down when you contribute to an HSA. How much? Let’s say a woman with a family income of $60,000 deposits $2,000 into an HSA. If she is in the 28% federal tax bracket, she saves $560 in taxes. And many states also allow you to deduct the amount of your contribution for state tax purposes.
Self-employed individuals can contribute on an after-tax basis and take an above the line deduction. Plus, they can deduct 100% of the cost of the premiums for their HDHP from their federal income taxes.
If your employer contributes to an HSA on your behalf, you are not subject to tax on those contributions either.
Withdrawals tax-free
Once the funds are in the account, you can withdraw them, tax-free, provided you spend the funds on health care expenses that the IRS considers to be eligible. What are these expenses? These are the same expenses that the IRS allows you to deduct once they exceed 7 ½ % of your adjusted gross income. Typical expenses are items like prescription and over the counter drugs, dental expenses, eyeglasses, hearing aids, as well as any coinsurance or deductibles.
Earnings tax-free
One of the biggest benefits of an HSA is that interest and investment return accrue to the account on a tax-free basis. You would incur tax only if you withdraw funds to use for expenses that are not qualified—and you would also incur a 10% penalty. Beginning at 65, you can withdraw the funds for any purpose without paying the penalty—and while you’ll pay income taxes on the distribution, presumably it will be at a time when your income is lower.
Investment options
You’re in charge and there’s flexibility. You may open an HSA with any institution that has IRS approval to offer them – for example, a bank or an insurance company. Typically, your employer will be working with an institution that can assist you with setting up your account.
Your investment options will differ, depending on the institution that holds your account. Among the choices that may be offered are:
* Certificates of deposit
* Stocks
* Bonds
* Mutual funds
* Money market accounts
Some of these options, such as mutual funds, may require a minimum balance to open. Also, the institution generally changes some administrative fee for managing the account.
Long-term savings
If you are healthy and can forestall dipping into your HSA for medical expenses year after year, there is potential for creating a nest egg for retirement through the magic of compounding. The amount of that nest egg will vary depending on the rate of return on your investment(s), the amount you and your employer contribute each year, your age when you started making contributions, how much you have withdrawn from the account over the years, and market conditions.
Benergy Portal Creates Total Access
Attention HR Directors! Offer your employees access to information about their account such as benefits enrollment, total compensation statements and FSA administration on one, easy to use web-based product, Benergy. The new PBG website offers a quick link to the Benergy portal right on the front page. Potential or first-time users can review demo's and learn more about the product by clicking on our main navigation link, "Products" and then "Benergy."
For quick introduction, Benergy is an online employee communication platform offering employees information about their employer's sponsored group benefits. The Benergy site, customized with your company's logo, is presented as...