Health Savings Accounts: Pay Medical Bills or Save For Retirement?

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Health savings accounts (HSAs) have existed since the law’s effective date in 2004. HSAs are tax advantaged savings accounts for current or future medical expenses. To open an HSA and make contributions, you must have a high deductible health plan, not be claimed as a dependent, have no other health coverage except what is permitted by the IRS and not be enrolled in Medicare. HSA accounts are portable whether you change insurance or change employers. There are no income limits to have an HSA.

Like a traditional IRA, contributions to an HSA are tax deductible and the earnings grow tax free. However, distributions from a traditional IRA are taxed and distributions from an HSA are not taxed, as long as they are used to pay qualified medical expenses. After age 65, distributions from an HSA that are not used for qualified medical expenses are taxed as ordinary income, just like a traditional IRA.

High Deductible Plans

High deductible health insurance plans (HDHPs) offer lower premiums and higher deductibles than a traditional health plan. HDHPs typically do not cover services or prescription drugs until deductibles have been met. At that time, the plan coverage provisions will dictate how much you will be reimbursed. You may still be required to pay co-pays and co-insurance after your deductible has been reached. To be recognized as a HDHP by the Internal Revenue Service, deductibles must be at least $1,300 for individuals and $2,600 for families, and the annual out-of-pocket expense cannot exceed $6,550 for individuals and $13,100 for families in 2017.

Contributions to Health Savings Accounts

Deposits to an HSA are tax deductible and the earnings grow tax free. In 2017, deposits are limited to $3,400 for self-only coverage and $6,750 for family coverage. A catch-up provision also applies for plan participants who are age 55 or over. For those individuals, the deposit increases to $4,400 for self-only coverage and $7,750 for family coverage. Contributions may come from employers, employees or any other person. The contribution limits are the same no matter the source of the contributions. Amounts included in an HSA can be invested in mutual funds and other investments typically used for retirement plan purposes.

Taxes on Health Savings Accounts

An HSA allows account owners to pay for current health care expenses and save for those in the future. The contributions are tax deductible, or if made through payroll deductions, are made on a pretax basis. The investment income on the HSA account is not taxed when earned.

Distributions From Health Savings Accounts

You can receive tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA. If you receive distributions from your HSA for other than qualified medical expenses, the amounts you withdraw are subject to income tax and may be subject to an additional 20% tax.

Insurance premiums are not considered to be qualified medical expenses except for certain long-term care insurance, COBRA, and Medicare and other health care coverage if you are over 65.

Health Savings Accounts After Your Death

If your spouse is the beneficiary of your HSA, upon your death the HSA will be treated as your spouse’s HSA. Your spouse can use the money tax-free for his or her own medical expenses. If someone other than your spouse is the designated beneficiary, the account will be closed and the money will be taxable to the beneficiary in the year you die.

Health Savings Accounts After You Turn 65

After you turn 65, you can take penalty-free distributions from your HSA for any reason. To be tax free and penalty free, the distribution must be used for qualified medical expenses. Other distributions from your HSA will be subject to ordinary income taxes.

At age 65 you can use your HSA to pay for Medicare parts A, B, and D, and HMO Medicare but not Medigap insurance.