For years, small business owners, the self-employed, and people who don’t get their health insurance from their employers have faced a dilemma: For quality health insurance premiums to be affordable, you need to set a fairly high deductible. On the other hand, any money you save is generally taxed. Which makes it that much more difficult to cover your deductible. That’s where health savings accounts come in.
The Health Savings Account, or HSA, lets you defer taxes on any money you contribute, in order to cover out-of-pocket medical expenses. The catch: To contribute, you have to buy a special kind of policy called a High-Deductible Health Plan, or HDHP.
High-Deductible Health Plans Explained. HDHPs are major medical policies with higher deductibles than one normally finds in other plans. Premiums low by restricting coverage to major medical events. The risk of less costly procedures or minor medical events is retained by the consumer, not the insurance company.
For policies covering only yourself, your annual deductible must be at least $1,200, as of 2012. The maximum annual deductible and other out-of-pocket expenses cannot be more than $6,050. For family coverage, the limits are $2,400 and $12,100.
HSA and HDHP Eligibility. To enroll in an HSA/HDHP, you must not be enrolled in Medicare, nor have coverage under any other health plan. Additionally, no one else must be claiming you as a dependent on their tax returns. The IRS considers you eligible for an HSA all year long if you were eligible on December 1st of the previous year. However, a special “testing period” may apply if there are any changes in your eligibility status.
HSA Contribution Limits and Taxation. As of 2012, the most you can contribute to an HSA is $3,100, and the limit for families is $6,250. Those aged 55 or over can contribute an additional $1,000 per year. Currently, the base contribution limits are indexed to inflation, but not the 55+ catch-up contribution limit. If you contribute too much, you will be liable for a 6% excise tax on the overage.
Contributions are tax deductible, and all growth in an HSA is tax-deferred. If you withdraw the money to pay for a bona fide medical expense, the amount withdrawn is tax free. However, any withdraws you make to pay non-qualified expenses, or for any other reason other than medical expenses, is taxable as ordinary income, and subject to a 10% penalty.
Preventive Care. Some plans will waive your deductible for preventative care. Examples include tests, checkups, mammograms and some diagnostic procedures.
Who Should Consider a HSA/HDHP?
HSA/HDHPs tend to work best for those who are in reasonably good health, with no reason to believe they will incur ongoing medical expenses.
- You are a small-business owner, sole proprietor or independent contractor.
- You don’t get coverage from a workplace plan.
- You and your family are in generally good health and don’t require routine, ongoing medical treatment.
- You have enough income to contribute each year.
- You are in a higher tax bracket. You want to keep premiums low.
- You can afford to absorb the risk of a $3,100 or $6,250 medical expense, should something happen to your family.
HSA/HDHP’s may not be for you if you will have trouble coming up with the deductible, or if you will wind up delaying needed health care because of the higher deductible.
Claiming the Deduction
To claim a deduction for a health savings account contribution, fill out an IRS form 8889, Health Savings Accounts, and submit it to the IRS along with your personal income tax return. You must use a Form 1040 or, if you are a non-resident of the United States, a 1040NR to claim the deduction; you cannot claim the deduction if you file using a Form 1040-EZ or a 1040A.
For complete information on health savings accounts, see IRS Publication 969. Contribution deadlines for HSAs work similarly to those for IRAs: You have until April 15, 2012 to make your 2011 contributions (however, the caps for 2011 are lower – $3,050 for singles and $6,150 for families.) Similarly, you have until April 15, 2013 to make your contributions for 2012, and so on.