Effective starting in 2004, health savings accounts (HSAs) provide a way to help save on medical costs.
To qualify, you must be covered by a health insurance policy with a minimum deductible of $1,000 for individuals and $2,000 for families in 2005. Maximum out-of-pocket costs for the medical insurance plan, including deductibles and copayments, must not exceed $5,100 for individuals and $10,200 for families in 2005.
If your plan meets those requirements, you can then set up an HSA account, where you can deposit pre-tax dollars up to your deductible each year. In 2005, these amounts are capped at $2,650 for individuals and $5,250 for families. These limits increase every year based on inflation. Individuals over the age of 50 can make a catch-up contribution of $600 in 2005 (increasing by $100 per year to a maximum of $1,000 in 2009). Contributions can be made by you, your employer, or a combination of both. There are no income limits or requirements for setting up an HSA.
Individual contributions result in an above-the-line tax deduction on your income tax return. Any contributions made by your employer are not taxable to you. Self-employed individuals and employers can deduct contributions as well as insurance premiums. Individuals not covered by an employer's medical plan can purchase a qualified medical insurance policy on their own and make tax-deductible contributions. However, premiums are not tax deductible for individuals.
Money in the HSA can be spent tax free on health care expenses, including eye care, dental expenses, prescription and non-prescription drugs, COBRA premiums, and qualified long-term-care services.
Unlike flexible spending accounts, you don't have to use all the money in the current year. Any unused amounts stay in your account and grow tax deferred. Thus, individuals who can afford to pay their deductibles from personal funds can use the HSA as a way to save funds on a tax-deferred basis. This may be particularly attractive to individuals who have made the maximum contributions to 401(k) plans and individual retirement accounts (IRAs), providing another way to save for retirement.
If you use funds before age 65 for other than qualified medical expenses, you must pay income taxes as well as a 10% penalty on the funds. After age 65, the 10% penalty is waived. At all times, the money in the account belongs to you.
After age 65, you can't make new contributions to an HSA, but you can still use money in the account to pay medical expenses, including premiums for Medicare Part A and B and the employee's share of medical insurance premiums paid by an employer.
Despite the benefits, not many employers currently offer HSAs, but that is expected to change in the near future. In a recent survey, 73% of companies indicated that they would add HSAs to their benefits by 2006 (Source: CNNMoney, October 22, 2004).