The Key Benefits of Health Savings Accounts
The HSA Tax Deduction
Health savings accounts (HSAs) are tax-deductible savings plans that allow you to put aside pre-tax dollars for future health care expenses. According to the Internal Revenue Service (IRS):
"An HSA is a tax-exempt trust or custodial account that a taxpayer sets up with a qualified HSA trustee. Distributions from an HSA are nontaxable if the funds are used for qualified medical expenses. A taxpayer must be an eligible individual to qualify to contribute to an HSA."
Pre-tax dollars are subtracted from your pay before withholding for taxes is calculated, so you don't pay tax on this portion of your income. Distributions from the HSA can be tax-free as well.
Eligibility rules require that you must be enrolled in a high-deductible health insurance plan. 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 requirements. The minimum annual deductible limit for 2020 is $1,400 for self-only coverage, or $2,800 for family coverage. Maximum out of pocket expense limits are $6,900 for self-only coverage and $13,800 for family coverage.
There are no income limitations to qualify for a health savings account. While individual retirement accounts (IRAs) require that a person must have earned income, there are no such requirement for HSAs.
Limitations on Contributions
There's a cap on how much you can contribute and save each year, as well. This amount can increase annually, although it doesn't necessarily do so. Contribution limits are $3,550 for self-only HSAs in 2020 or $7,100 for family HSAs. Contributions made by your employer count toward these limits.
Those who are age 55 or older can contribute an additional $1,000. This "catch-up" contribution isn't indexed for inflation, so it's the same amount from year to year. It can be made at any time during the year.
If you're enrolled in Medicare, you are not allowed to make any HSA contributions or tax deductions.
How Contributions Are Treated
Contributions to an HSA are tax-deductible on your Form 1040 tax return 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 itemized medical deductions are limited to expenses paid in excess of 7.5% of your adjusted gross income. This threshold has been the same for tax years 2017, 2018, and 2019.
According to the IRS, "Contributions to your HSA made by your employer (including contributions made through a cafeteria plan) may be excluded from your gross income." But, of course, if you aren't paying taxes on your own contributions, you can't also claim a deduction for them.
Contributions for a particular tax year are due by the same day as the filing deadline for your tax return, which is usually April 15, unless this date falls on a weekend or holiday. In that case, the deadline is the next business day.
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 an HSA are tax-free as long you use the money to pay for qualified medical expenses. "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.
They also include mileage traveling to and from treatment, but not costs associated with items that are just considered "healthy," like vitamins or gym memberships. They include costs incurred on behalf of yourself, as well as your spouse and dependents.
Different State Rules
Not all states mirror federal rules for taxation of HSAs. As of 2019, neither New Jersey nor California allows deductions for HSA contributions. They also tax earnings and capital gains within HSAs.
Alabama used to have similar rules as New Jersey and California, but it conformed to federal rules in 2018.
Tennessee and New Hampshire tax earnings and gains, but not contributions.
Using an HSA as a Tax-Planning Tool
HSAs accumulate earnings and income without being subject to forfeiture the way flexible spending accounts are if they're not used.
Money held inside an HSA can be withdrawn at any time for qualified medical expenses, so an HSA can be used to accumulate tax-free income for use later in life. You can build tax-free savings for future medical expenses as you age.
HSAs offer people with few medical expenses a tax deduction upfront in the year that contributions are made.
Where and How 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 reported on Form 1040.
Internal Revenue Service. "What Is an HSA?" Accessed May 22, 2020.
Internal Revenue Service. “Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans,” Page 3. Accessed May 22, 2020.
Internal Revenue Service. “Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans.” Accessed May 22, 2020.
HealthCare.gov. “High Deductible Health Plan (HDHP).” Accessed May 22, 2020.
HealthCare.gov. "Health Savings Account (HSA)." Accessed May 22, 2020.
Internal Revenue Service. “HSA Contribution Limits.” Accessed May 22, 2020.
Internal Revenue Service. “Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans,” Page 8. Accessed May 22, 2020.
Internal Revenue Service. "Health Savings Accounts (HSA): Limit on Contributions (Continued)." Accessed May 22, 2020.
Internal Revenue Service. “2020 Instructions for Form 1099-DIV,” Page 1. Accessed May 22, 2020.
Internal Revenue Service. "Publication 502 (2019), Medical and Dental Expenses." Accessed May 22, 2020.
ABD Insurance & Financial Services. "California and New Jersey HSA State Income Tax." Accessed May 22, 2020.
National Conference of State Legislatures. “Health Savings Accounts and the States.” Accessed May 22, 2020.
Justia. ”2016 Code of Alabama Title 40 - Revenue and Taxation.” Accessed May 22, 2020.
Vanguard. “HSAs: An Off-Label Prescription for Retirement Saving,” Page 5. Accessed May 22, 2020.