Whether your health insurance is provided by your employer or you buy it on your own, you probably have a “high deductible” version available to choose.
This plan usually offers you lower premiums, in exchange for your willingness to pick up a larger portion of the costs (up to a certain limit).
But the lower premiums are only one of the benefits of using a high deductible health insurance plan. For certain people in certain situations, the ability to open (and fund) a Health Savings Account (HSA) can provide even bigger savings from Uncle Sam.
Although you don’t necessarily have to open an HSA if you have a high-deductible plan, you have to have a qualifying high-deductible plan to open an HSA.
You (and perhaps your employer) make tax-deductible contributions to the HSA, and any interest or gains earned on the deposits are sheltered from taxation.
When you incur qualified health care expenses that would normally be paid by you (such as items that are below the limit of your deductible), you can make tax-free withdrawals from the HSA to pay for those expenses.
If you don’t use all of the HSA money in a particular year, you don’t lose it. Instead, it stays in the account to be used in the future.
If you pull the money out before turning 65 for reasons other than to pay for qualified medical expenses, the withdrawals will be taxed as ordinary income, and a 20% penalty will be tacked on as well.
But any balance left at age 65 can be withdrawn for any reason, and the withdrawals will be taxed as ordinary income (just like if it were an IRA).
For a list of expenses that may meet the standard for tax-free withdrawals from an HSA, go to Publications 969 and 502 at www.irs.gov, or visit tinyurl.com/hsaexp.
How much and when
For 2015 the contributions limits to an HSA are $3,350 for individuals, and $6,650 for families. Those willing to admit to being over 55 and not enrolled in Medicare can kick in an additional $1,000.
The HSA contributions for the 2015 tax year can be made any time after the first of the year, but must be made before April 15th of 2016.
To eventually take tax-free distributions from an HSA to cover qualifying medical expenses, you must establish the account before you incur any of the aforementioned expenses.
Who should contribute?
If you have an option between a standard health insurance plan and one with a high deductible that can then be paired with an HSA, you should know that the latter is better for some more than others.
First, you should be in relatively good health, and unlikely to incur significant health care costs (of which you would have to pay a significant portion, up to the amount of your deductible).
Next, you should fall in to one of two categories, based on your income. If you’re on the lower end of the earnings spectrum, your ability to save for retirement and pay for health insurance (and taxes) is likely to be limited.
In this case it may actually be better to choose a high-deductible plan, and pair it with an HSA. Your premiums will be lower, and whatever you can afford to deposit in to the HSA will reduce your income tax bill.
Eventually, whatever portion of your HSA that you don’t use can be rolled over, and used to fund your retirement expenses after age 65.
However, if you’re in a high-income and high-tax bracket, you may want to proceed a little differently. Start by allocating enough income to max out your contributions to any pre-tax retirement savings plans (such as 401ks and 403bs).
Then contribute as much as possible to your pre-tax HSA. Depending on your tax bracket, you could save almost 40 cents in taxes for every dollar you contribute to the HSA, not to mention the lower premiums you will pay on your health insurance.