There is no doubt that the HSA, or health savings account, is an increasingly popular vehicle for helping Americans take charge of their own health care choices. What is less clear is how to handle the presence of an HSA account in an individual’s savings and investment portfolio at tax time. If you participate in an employer-sponsored health savings account, your employer may view the HSA as a way to maximize your employee benefits while keeping costs lower. You may see the HSA as a way to safeguard yourself and your family against future health care or financial unknowns. But the Internal Revenue Service (IRS) also has its own view of HSAs. As a participant in a health savings account, it is important for you to understand how the IRS sees HSA accounts and how to handle these unique accounts for tax purposes.
How the IRS Defines the HSA
The IRS defines a health savings account as “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 do not need to get any type of special approval or permission from the IRS to open an HSA. However, you must establish a relationship with a trustee — an individual whom the IRS has approved to oversee financial accounts. Since the HSA is fundamentally a financial savings and investment account, your trustee may be a bank, your employer, your insurer or another authorized agent. If you are participating in an employer-sponsored HSA plan, you can ask your employer for information on health savings accounts to find out who the trustee is.
Establishing IRS Eligibility to Participate in a HSA
In addition to forming a relationship with an IRS-approved trustee, you must establish that you are eligible to participate in a health savings account. It is also important to check for changing IRS regulations regarding HSAs from year to year.
- You are eligible if you are a participant in a high-deductible health insurance (HDHI) plan.
- You are eligible if you do not participate in any other type of health care plan that is not included in IRS-approved additional health care plans.
- You are eligible if you are not enrolled in Medicare.
- You are eligible if no one else can claim you as a dependent on their tax return.
Understanding the High-Deductible Health Insurance Plan
Unless you currently participate in a high-deductible health insurance plan, you may not be sure how to tell whether your health care plan qualifies. The IRS has strict regulations regarding what qualifies as a high-deductible health insurance plan.
- Whether you have an individual or a family policy, your deductible must be higher than that of the typical insurance plan.
- Your maximum annual expenses, including deductible and out-of-pocket medical expenses, must be capped at a certain level.
- Your plan may, but is not required to, cover preventative health care expenses.
HSA Contributions and Distributions
The IRS also has specific regulations regarding contributions to and distributions from an HSA.
- Cash only. All contributions to an HSA account — whether for an individual or family account — must be made with cash. No contributions coming from stocks, property or securities are permitted.
- Contribution limits. You must abide by all limits to monthly or annual contributions set up by your specific plan.
- Qualified medical expenses. Distributions must be taken for qualified medical expenses only. Insurance premiums (except for long-term care premiums or premiums paid during unemployment) and non-prescriptions drug expenses (except for insulin) cannot be considered qualified medical expenses, but expenses incurred before the start date of the HSA are.
- Tax free limitations. Distributions taken out of an HSA are tax free if they are used for medical expenses. Otherwise they are taxed and a 10 percent penalty is assessed if funds are withdrawn for non-medical purposes before age 65.
- Employer-sponsored HSA plans. If you leave your employer, you can roll over your HSA account into a new HSA account and it will not be counted as income.
Because understanding the complexities of IRS regulations is never the easiest of tasks, it is also advisable to contact a tax professional if you find you have more questions about HSAs and taxes.
About the Author: Wiley Long has been helping individuals and families get coverage and save money for over 20 years. He owns HSA for America.