The Key Benefits of Health Savings Accounts

HSA Plans—A Tax-Advantaged Way to Save for Future Healthcare Expenses

A medical bill for laboratory services
••• © William Andrew / Photographer's Choice RF / Getty Images

Money you set aside in a health savings account (HSA) can be double tax-free. Contributions are tax-deductible when they're going into the HSA, and distributions from the HSA can be tax-free as well. 

According to the IRS, "A health savings account is a tax-exempt trust or custodial account that you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur. You must be an eligible individual to qualify for an HSA." 

How an HSA Works 

HSAs are tax-deductible savings plans that allow you to save pre-tax dollars for future healthcare expenses. Pre-tax dollars are subtracted off the top of your pay before withholding is calculated. 

You must be enrolled in a high-deductible health insurance plan to qualify. You can't be covered by another type of health insurance plan such as an HMO or a PPO-type plan.

The high-deductible plan must meet certain rules. There must be minimum and maximum limits on your annual deductible and how much you must pay out of pocket. As of the 2017 tax year, the combined limits are $6,550 for self-only coverage and $13,100 for a family plan. Minimum annual deductibles are $1,300 if you're insuring only yourself and $2,600 for family coverage. 

There are no income limitations to qualify for a health savings account. By contrast, individual retirement accounts require that a person has earned income. There is no such requirement for HSAs.

How Contributions Are Treated 

Contributions to an HSA are tax deductible on the first page of Form 1040 as an adjustment to income. You don't have to take them as an itemized deduction for medical expenses, which can have limited tax impact because these itemized deductions are limited to expenses paid in excess of 7.5 percent of your adjusted gross income. This threshold is scheduled to increase to 10 percent in 2019. The health savings account does not have a similar limitation.

Contributions for a particular tax year are due by the same day as the deadline for the filing your return, usually April 15. For example, you can contribute savings for tax year 2018 from January 1, 2018 to April 15, 2019.

There's a cap on how much you can contribute and save each year and it can increase annually although it doesn't necessarily do so every year. If you're single, you can contribute up to $3,450 for 2018, up from $3,400 in 2017. The contribution limit for a family plan is $6,850 in 2017, increasing from $6,750 in 2017.

Unfortunately, no HSA contributions or tax deductions are permitted if you're enrolled in Medicare Part A or Part B.

Earnings Are Tax-Exempt 

Earnings, such as interest and dividends from the money contributed to an HSA, are tax-exempt at the federal level. Interest or other investment income earned on the contributions are not included on your tax return.

Withdrawing From Your HSA 

Withdrawals from a health savings account are tax-free as long you use the money to pay for qualified medical expenses. These "qualified" expenses are detailed in IRS Publication 502, Medical and Dental Expenses, and they include most medical costs from birth control pills to guide dogs to surgery.

Using an HSA As a Tax-Planning Tool 

Health savings accounts achieve tax savings in two ways. First, HSAs accumulate earnings and income without being subject to forfeiture the way flexible spending accounts are. Money held inside an HSA can be withdrawn at any time for medical expenses so an HSA can be used to accumulate tax-free income for use later in life. You can build up tax-free savings for future medical expenses as you age.

Second, HSAs can be used to pay for current medical expenses. HSAs offer people with few medical expenses a tax deduction upfront in the year that contributions are made. 

Where to Claim the Deduction

Financial institutions report HSA contributions using Form 5498-SA, which is sent to both the taxpayer and to the IRS. You can then report your tax-deductible HSA contributions on Form 8889 with the total contributions also reported on Form 1040.

Note: The provisions for HSAs are among those that were not affected by the Tax Cuts and Jobs Act that was signed into law in December 2017.