As the cost of medical treatment continues to grow, a health savings account (HSA) may be a benefit for many. If you have a high deductible health plan (HDHP) or if you’re considering getting an HSA vs FSA (flexible spend account), this article explains everything you need to know before opening a health savings account.
What is a Health Savings Account?
A health savings account or HSA is a tax-advantaged method used to pay for qualified medical expenses. Generally speaking, an HSA provides the following benefits:
HSA interest and other earnings on your assets are tax-free
An HSA is portable in can move with you as opposed to being employer-specific
While HSA’s have clear tax advantages not everyone qualifies for an HSA. HSA’s were created so that individuals covered by high deductible health plans could receive tax-preferred treatment for the money they save for medical expenses. These eligibility requirements include:
The account holder must be covered by a single high-deductible plan
The account holder must not be eligible to be claimed as a dependent on another’s tax return
The account holder must not be enrolled in Medicare.
How do I set up and HSA?
Based on IRS guidance, an HSA does not need special permission or regulatory authority from the IRS. Trustees such as banks, who have been approved by the IRS, can provide HSAs. If you are employed, your company may have a trustee they currently work with. If you’d like to learn more about opening an HSA, connect with your local banker or visit our HSA page here.
Does a Health Savings Account Have Contribution Limits?
Yes, a health savings account does have contribution limits. Limits are primarily based on your health plan coverage, age, and eligibility date. Other factors that impact your contribution limit include the following:
If you are eligible on the first day of your tax year’s last month you are then eligible for the entire year.
If you change your coverage during the year
Generally speaking, a trustee should be able to help you access your contribution limits. However, the IRS also provides contribution worksheets to determine your maximum contribution.
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Advantages and Disadvantages of Health Savings Accounts
There are two sides to every coin: this is true with an HSA. The advantages associated with an HSA include:
Savings on the cost of insurance
Tax-free distributions for qualified expenses
As discussed earlier many of the primary advantages are based on tax incentives. However, there are also some disadvantages to HSAs. These disadvantages include:
Distributions unrelated to medical expenses are subject to income tax as the contributions were tax-deferred and the funds received are unrelated to qualified medical expenses. More importantly, these distributions may also be subject to20% additional taxation.
Overall, the advantages of an HSA are helpful from a tax perspective especially if you are in a good position to save for health needs and have additional savings options to avoid incurring penalty fees or additional taxation.
HSA vs. FSA
HSAs are not the only medical-related financial account. Another common account often compared to an HSA is a Flexible Spending Agreement or FSA. FSAs are considered beneficial because employer contributions can be excluded from gross income. However, FSAs have several disadvantages when compared to HSAs. Some disadvantages include:
FSA contributions are forfeited at the end of every year
If contributions exceed max distribution amounts they are forfeited
FSAs cannot move with you, they are employer-based
FSAs can only be used for medical expenses
Final Thoughts on HSA Accounts
Overall, if you qualify for a health savings account, it’s definitely an ideal option for reaping both tax advantages as well as healthcare savings. More importantly, an HSA allows you and others to contribute to your long-term healthcare plans while still allowing you to grow your contributions over time. Are you ready to open an HSA? If so,find a local banker today.