Tag Archives: HSA Benefits

Health Savings Accounts – the Pros and Cons

Overview

A frequent question those considering Health Savings Accounts often ask is, “What are the Pro’s and Con’s of HSA’s”? There are many different aspects of HSA’s that may benefit your particular situation, but there are some disadvantages as well. To clarify the issue, we have summarized the pro’s and con’s of Health Savings Accounts in a digestible format. Hopefully this information can help you decide if participation in HSA insurance is right for you.

    The Pro’s of HSA’s

There are many reasons that Health Savings Accounts are beneficial and can help your family financially. Enrolling in HSA eligible insurance and opening a Health Savings Account can offer you the following benefits:

Lower Insurance Premiums

A core tenant of High Deductible Health Plans (HDHP’s) is a trade off of lower monthly premiums in exchange for a higher deductible. This reduces guaranteed costs (premiums) at the expense of occasional costs (deductible). This benefits healthy individuals and those that can pay for limited out of pocket care.

Lower Cost of Health Care

Part of the HSA’s triple tax advantage is that qualified medical expenses are paid on a tax free basis. The actual mechanism occurs first through tax free contributions to a Health Savings Account, then spending those dollars on qualified medical expenses. By not paying tax on healthcare, you reduce your cost by your marginal tax rate, which can be 15%, 25%, or 35%.

Lower Taxes

HSA’s are an effective vehicle to lower your income tax burden. For those in strong financial standing, they can allocate part of their income to an HSA instead of paying full taxes on it, creating a nest egg and lowering that year’s taxable income.

Keep the Money Forever

Unlike Flexible Spending Accounts (FSA’s) whose contributions expire at year end (the horror!), anything you contribute to your HSA remains yours for life. There is no need to operate under a “use it or lose it mentality”. This makes an HSA an investment since it becomes savings that you can spend as you see fit.

Get Started Quickly

Unlike other health plans and savings vehicles, you can open Health Savings Account very quickly. It does not require much paperwork or employer approval; all you really need are an HDHP and an account with a financial institution. Moreover, in the first year you can utilize the Last Month Rule to contribute the max amount, even if you only had partial year insurance.

Retirement Investment Vehicle

A major benefit of HSA’s occurs when the account holder turns 65, at which point HSA funds can be spent on anything without penalty. This differs than prior to age 65, when using HSA’s for non qualified medical expenses invokes both tax and penalty. Note that HSA funds spent on non qualified medical expenses will be taxed (like a 401(k)) but not penalized. However, the benefit is they would have grown tax free in your HSA. That means you can save diligently through your working years, spend what you need on medical, and use the rest to pad your retirement account.

Unemployment Safety Net

Health insurance premiums are generally not considered a qualified medical expense. However, if you are collecting government unemployment benefits, you are allowed to spend your HSA on health insurance premiums during that time. That means your HSA can function as your own unemployment insurance and help you through difficult times after losing a job.

Employer Contributions

If you are so lucky that your employer makes contributions to employee HSA’s, you may be able to receive some of that free money by signing up an HSA. This incentive can factor into your calculation when determining what type of insurance to buy.


The Con’s of HSA’s

Even though there are many positive aspects of HSA’s, there are some Con’s as well. Generally these involve the insurance itself and the IRS rules surrounding the account mechanics. Either way, it is important that you are aware of the following when making a decision about HSA’s.

Reduced Insurance Choices

Since not all insurance plans are HSA eligible, if you want an HSA you will be restricted to a subset of health insurance plans. These plans may or may not fit all of your health care needs, so be sure that your needs are being met by the insurance. In that regard HSA eligibility may be a “bonus” or a secondary factor in deciding which insurance to purchase.

Higher Deductible

The increased deductible required by HDHP’s is a reality that can cause financial hardship. It is not fun to have to spend $X,000 before your insurance kicks in, and the higher the number, the more you spend first. That is why if you have high medical costs an HDHP may not be the best fit for you.

Money tied up for Health Care

One downside of HSA contributions is that they are illiquid. Once they have been contributed, they are designated for medical expenses and nothing else. This can cause financial issues when you have a bunch of money in your HSA but have a non-medical need for the cash. There are a few ways to cash out an HSA but they often involve taxes and penalty.

Risk of Penalty and Fines

There are quite a few rules that govern the use of HSA’s, and some of them are very specific and (dare I say) onerous. By using an HSA you receive benefits but run the risk of putting yourself in a position to actually pay penalties if something goes wrong. The most common cause of fines is the Last Month Rule, so it is in your interest to familiarize yourself with it and other HSA rules.

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Who can Contribute to a Health Savings Account?

This is a fairly frequent question from readers who ask, “Who can contribute to an HSA?” or “Who can contribute to my HSA?” These questions take a couple of forms and includes some assumptions, so we will first explain the basics and move to the specifics.

You must have an HSA for anyone to contribute to it

First things first, you must at least open and have a Health Savings Account to be able to contribute to it. Contributing isn’t just some earmark/declaration you make when you file taxes; instead, HSA contributions go to an actual bank account, just like what you might use for checking and savings. This bank account is yours forever and is designated for qualified medical expenses. At retirement age, you can use the account for whatever you like.

You must have HSA eligible insurance in the year to have HSA contributions

A second requirement of contributing to your HSA is that you have HSA eligible health insurance during the year you wish to contribute. This also applies to employer or other contributions (see below) you may receive. You must have a high deductible health plan (HDHP) that meets that year’s HSA requirements to make or receive any contributions. Unfortunately, this prevents you from contributing to an old Health Savings Account if you no longer have qualifying insurance. You have to have coverage at some point during the tax year to make contributions. The key phrase “during the tax year” is important there. This does not mean that you need to currently have coverage to contribute to the HSA. If you had HSA eligible coverage at any point during the year, you can at least make a partial contribution to your HSA.

For example, assume that you had HSA eligible self-only insurance from January – July, and then ended coverage. You made no contributions during that time. You might think that since you made no contributions, you missed out and can contribute nothing to your HSA for the year. This is is not the case. In fact, you are allowed to contribute on a monthly pro-rata basis for the year, in this case 6/12 months or 1/2 of your contribution limit. Health Savings Account contributions and limits are viewed on yearly timeline, and you can even contribute to your HSA in the following year, using what is called a Prior Year Contribution.


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Now onto who can actually make contributions to your Health Savings Account.

1) The account holder (you) can contribute to your HSA

Of course, you can make contributions to your own HSA. This is the most common form of contribution and can take two forms, either a cafeteria plan contribution (pre tax), or a manual contribution (post tax) . While the method and timing differs, both result in the same tax benefits once you file taxes. Cafeteria plan contributions are arranged by your employer and remove your HSA contributions from your paycheck on a pre tax basis. These amounts are deposited into your HSA and you enjoy immediate tax savings. Alternatively, you can make manual contributions to your HSA. This is probably the most common method and involves getting paid, paying taxes, and then depositing or transferring post tax money to your Health Savings Account. At tax time, these deposits are retroactively removed from your taxable income, so you reap the tax deduction benefit at tax time.

Form 8889 line 2 contributions

The method in which you make contributions to your HSA also determines how you file HSA tax Form 8889. The above image shows that manual contributions (post tax) made on line 2, whereas cafeteria contributions (pre tax) are made on line 9 (see next image).

2) Your employer can contribute to your HSA

You can also receive employer contributions to your Health Savings Account. This is a great perk because your employer is in effect giving you free money to use for your healthcare. The schedule and amounts at which they contribute will vary based on your employer. Some employers will provide a small contribution to your HSA’s, whereas others may be very generous and fund your entire HSA. Either way, employer contributions are factored into Form 8889 on Line 9.

Form 8889 line 9 employer contributions

Please note, that per the above discussion, that you must have HSA eligible insurance to receive employer contributions to your HSA. So if your employer offers a great benefit like a HSA contribution, but you choose a non-HSA eligible insurance, you cannot take part in that benefit.

3) Other people can contribute to your HSA

Another benefit of Health Savings Accounts is that anyone can contribute to your HSA. This means that you can contribute to anyone’s HSA, and conversely that your parent, grandparent, rich aunt/uncle, or friend can contribute to your HSA. The best part is that the recipient of the contribution receives the tax deduction for the amount contributed, so that is a second order effect, besides having funds in the HSA.

Form 8889 line 2 other contributions

Note that you must declare contributions from others on your Form 8889 on line 2.

Note: all contributions count toward your contribution limit

Remember that all contributions made to your Health Savings Account count toward your yearly contribution limit. This means that you must take into account employer contributions (and contributions from ‘others’) when you determine how much can be contributed to your HSA for the year.

For example, say you have self-only HSA eligible insurance for all of 2016, affording you a $3,350 maximum contribution limit. If your employer generously contributes $3,000 to your HSA, and your parents chip in an additional $300, you would only be allowed to contribute $50 yourself without incurring excess contributions.