Stuff happens, and life happens. That, in essence, is the reason we have health insurance. The seasons rarely pass without catching a cold, suffering from allergies, or needing an adjustment because we slept wrong. Health insurance can cover all the above, and then some!
Health insurance, however, can be a complicated and finicky service. Navigating through health insurance can be bumpy, and it often leads us into uncharted waters. That’s where the HSA comes in. ‘HSA’ is an acronym for Health Savings Account, and it aims to make paying for healthcare services easier.
While the HSA takes some of the issues out of paying for healthcare services, some points could benefit from a little clarification. So, read on to learn the details of an HSA, and what’s up with the contribution limits.
History of the HSA
In 2003, President George W. Bush signed a law establishing the Medicare Prescription Drug, Improvement, and Modernization Act. The HSA was a piece of this act, to help those in high-deductible insurance plans afford their healthcare services. They established the HSA in answer to the medical savings account system (MSA). The MSA is also paired with high-deductible health insurance plans, but only for self-employed individuals or small businesses.
Both the HSA and MSA are funded by contributions during the payroll process, using pre-tax dollars.
When the HSA arrived on the scene, government statistics showed that employees covered by high-deductible health insurance plans increasingly enrolled in HSAs. However, income largely determined at what rate. Meaning, the research shows that individuals at higher income levels are more likely to enroll in an HSA.
The Savings in an HSA
An HSA is similar to a personal savings account in a few ways, but there are also clear differences. So, for the sake of clarity, let’s start with the differences.
First of all, to qualify for an HSA an individual must be enrolled in a high-deductible healthcare plan. This is important because the funds in an HSA likely wouldn’t cover the cost of healthcare services in its entirety. The HSA is also different from a personal savings account because the contributions are pre-tax. If an individual contributes to a regular savings account, the contributions are not pre-tax. In fact, the money they’re adding has probably already been taxed. Along with this, any earnings on a savings account are also subject to taxation.
So, how is an HSA similar to a personal savings account?
Well, for starters, both the HSA and a personal savings account can be funded by payroll or by another party. For example, while an employee may be making contributions to an HSA, their employer or a family member may also be making contributions on that person’s behalf. The HSA is also similar to a savings account in that both can draw interest on contributions.
Many people have heard of an FSA, or Flexible Spending Account, which is often confused with an HSA. Something that distinguishes the HSA from the FSA is that the HSA can draw interest on contributions. The FSA, however, is not an interest-bearing account.
The Function of the HSA
This is how the HSA works: A person enrolled in a high-deductible health insurance plan opens an HSA account. A “high deductible plan” is one that has an annual deductible amount of at least $1,300 for individuals and $2,600 for a family. The idea being, the individual can use the money you’ve saved in your HSA to pay these high deductibles.
Pros of the HSA
There are many great reasons to contribute to an HSA. So, let’s have a look at some of those reasons!
- The HSA saves money where taxes are concerned. Think about it this way: If a person contributes $100 to an HSA through payroll, then the contribution reduces their tax liability by $100. If that person’s Federal Income Tax (FIT) rate is 15%, then the tax savings is $15 for every $100 up to the contribution limit. If an individual makes an after-tax contribution to an HSA, then the contribution amount is going to show up on your W-2 at the end of the year. This effectively reduces your taxable income for the purposes of filing taxes.
- The HSA requires no minimum contribution. This means you can contribute more or less to your HSA, depending on the year or your needs. While there is a maximum contribution amount, there is no minimum contribution amount. This is another difference between the HSA and FSA because the FSA typically requires a minimum contribution amount.
- The HSA can be used to pay for a myriad of healthcare costs. Co-pays, prescriptions, and dental services are among the many things individuals use HSA funds for. Additionally, with a doctor’s note, in certain situations, individuals can use HSA funds to pay for over-the-counter drugs.
- An HSA account allows tax-free withdrawals for qualified medical expenses. So, while an individual is not taxed on the contributions to the HSA, the withdrawals from the account are not taxed, either. Further, any interest earned on funds in the HSA account is not taxable either.
- HSA funds can roll over. Meaning, the funds collect year to year. For those familiar with an FSA, another thing that stands out about the HSA is that the funds can be carried over from year to year. While the FSA can only carry over a portion of funds, or allow an extension for the spending of funds, all of the HSA funds may be carried over for use in the following years. This makes the HSA an excellent option for those years that healthcare costs fluctuate.
Cons of the HSA
By now, you can see that there are many great reasons to contribute to an HSA. There are, however, a few things that you will want to be aware of regarding the HSA.
- The HSA requires coverage under a high-deductible healthcare plan. High-deductible plans require you to pay a high deductible before they begin chipping in for a portion of the healthcare costs.
- The HSA can play mind games. That sounds strange, right? But research shows that some people are reluctant to relinquish healthcare funds they have worked so hard to save.
- An HSA account can have some tax penalties and fees. The magic number to remember here is 65. Individuals have to pay taxes and penalties on any non-qualified expenses if they withdraw funds before age 65. Additionally, some accounts do charge monthly maintenance and per-transaction fees.
- The HSA has a contribution limit. This is the thing that is the negative to the rollover’s positive: While it’s great that an individual can roll over the funds each year, an individual can only contribute so much each year. The downside to that is that if a person anticipates expensive healthcare costs, there is still a maximum contribution amount, which means that the remaining cost is not eligible for a tax break.
HSA Contribution Limits for 2020
While the HSA contribution limit fell on the list of cons for an HSA in general, the good news is that the IRS has announced that HSA contribution limit has increased for 2020. The new limit is $3,550 for individuals and $7,100 for families. This is up from the $3,500/$7,000 limits for 2019.
While the increase isn’t groundbreaking, it is still something, with the intention of offsetting a little inflation.
Life Happens, Grab Your Umbrella
The critical takeaway is that an HSA gives individuals and families a way to cover their out-of-pocket healthcare costs. The HSA is also a great way to save money that would otherwise go to taxes, and there’s no ‘use-it-or-lose-it’ policy. So if your company offers a high-deductible healthcare plan, it’s a good idea to set up an HSA. Just make sure that everyone is familiar with the requirements and contribution limits of the HSA!
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This is not meant to provide legal counsel or advice. Every situation is different. Please contact an HR professional or employment attorney before taking any action.
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