What is a Health Savings Account?
Health savings accounts (HSAs) allow individuals to save money for health care expenses on a tax-deferred and tax-free basis. This law was signed into law on December 8, 2003 and became effective on January 1, 2004. The tax deferred money can be invested into mutual funds, stocks, cash or bonds and can earn interest. The money can only be used for medical expenses otherwise taxes and a possible penalty may apply. Individuals with high deductible health insurance plans are eligible to open a health savings account. High deductible insurance typically require $1,000 or more in out of pocket expenses before it can qualify as such.
In 2003, health savings accounts were introduced as a part of a “consumer directed health care” initiative. The government encouraged these programs as a means to control health care costs. Health care companies and the government assumed that physicians would have an incentive to lower their health care costs if the physicians had to compete for a patient’s business. Consumers would also demand better care if they were spending their own money as opposed to a company’s or insurance company’s money. How well this has worked is obviously up for debate.
Individuals who are generally healthy will typically benefit from investing in a health savings account as it’s an effective way to pay for routine doctor visits, prescriptions, and procedures. However, individuals who may need immediate health care should assess whether or not they can afford their deductible and weigh the options. If you have a possible need for an expensive procedure in the next few years it may be far cheaper to pay the high deductible instead of putting money aside in savings that may not cover everything and have little time to reap the tax benefits.
How Does a Health Savings Account Work?
Funds deposited into a health savings account will continue to accumulate tax-deferred from year to year if they are not spent. A lot of people mistakenly assume these accounts are “use it or lose it” but that actually applies to Flexible Spending Accounts, or FSAs. The funds accumulated in the account are the individual’s and are not owned by your insurance provider. The funds may generally be withdrawn at any time, but in order to withdraw the funds without paying taxes on the gains or be assessed a 10% penalty they must be used for a qualified medical expense. Qualified medical expenses include:
- Insurance Deductibles
- Chiropractic Care
- Hearing Aids
- Some Cover Mammograms
- Prostate Exams
- Colon Cancer Screenings
- Pap Tests
- Well Baby Care
- Annual Physicals
- Medical Transportation Expenses
- Non-prescription Medications, until 2011
However, beginning in 2011 over the counter medical expenses will not be covered. If the individuals need to withdraw the money for non-medical expenses, then those funds will incur penalties. You should refer to the guidelines to determine the exact penalties associated with non-medical expense withdrawal.
Each year consumers may contribute up to a maximum amount to the health savings account. Depending upon the person’s familial status, the amount varies. The maximum amounts are listed below:
• Individual with Self Coverage (2010): $3,050
• Individual with Family Coverage (2010): $6,150
• Catch Up Contributions for Age 50+ (2010): $1,000
Other than the maximum contribution, individuals can contribute as little as desired. You also can decide which company will manage the account and subsequently choose what type of investments to make with the money in the account.
According to America’s Health Insurance Plans (AHIP), as of January 2009, nearly 8 million people were covered by the health savings account. Most were covered under a group plan which comprised 6.2 million of the people enrolled. Nearly, 1.8 million people are covered by individual policies. That number has increased since 2008 when only 6.1 million were covered under this type of program.
Statistics show that on average most people withdraw half of what they put into their HSA each year. For instance, if the average annual deposit was $2,100, then the average withdrawal was approximately $1,000. Individuals can withdraw from the account in a variety of ways. Some health savings account providers allow the contributor to have a debit card to withdraw funds. Other health savings accounts provide checks for contributors to withdraw funds. And some will allow you to make payments on your own and submit for a reimbursement.
The process will depend upon the provider you select which means it’s important to choose the right provider for your needs. The checks or debits can be made payable to anyone. However, those checks may incur a 10 percent penalty along with income taxes if it’s determined the payment was not for a qualified medical expense. Therefore, make certain to plan accordingly to avoid penalties and taxes. If the person is over the age of 65 or disabled at the time of withdrawal, then the 10 percent penalty may be waived.
Who Can Establish a Health Savings Account?
To qualify for a health savings account individuals must be under the age of 65 and possess a high deductible health insurance plan. If there is a spouse covered on the insurance, both must fall under the high deductible. Furthermore, each individual can only be covered by the high deductible health insurance without having a secondary provider. However, the covered can possess vision, dental, disability, and long term care insurance in addition to the high deductible health insurance plan which are not typically covered under regular health insurance plans.
According to one study, 46 percent of the health savings account holders were from a lower to middle income community with a median income between $25,000 and $50,000. Thirty-four percent of the individuals lived in middle income neighborhoods between $50,000 and $75,000. Twelve percent lived in an upper income neighborhood with a median income of $75,000 to $100,000. Three percent and five percent represent the lowest income neighborhoods and highest income neighborhoods, respectively. The low income neighborhoods represent median incomes below $25,000, and high income neighborhoods represent people with median incomes above $100,000.
Where Can You Set up a Health Savings Account?
Some employers offer health savings accounts to their employees so that is a good place to start. Employers may allow employees to contribute to a health savings account before their income is taxed as it comes right out of your paycheck. Some employers may even match what the employee contributes or fund the entire health savings account for the employee. Since each plan offered at the employer level is different you will want to check with your own employer to get the details.
For those who sign up for an independent health savings account through an insurer or bank, then the contributions made annually may be filed as a deductible expense on your taxes. Many of the insurers that offer health savings accounts are available on eHealthInsurance. Other options may be available by contacting the National Association of Health Underwriters. Some examples of health insurance companies that offer health savings account are listed below:
- United Healthcare
- Anthem Blue Cross Blue Shield
- Kaiser Permanente
- Providence Health Care
- Rocky Mountain Health Plans
As of 2006, over 600 banks were also offering health savings accounts to individuals and to companies. Even more banks are offering this feature today, so another safe bet may be to check with your own local bank and see if they have an HSA plan available.
Some people are obviously hesitant about this particular savings plan compared to traditional health insurance. However, this plan gives you much more control over your money. With an HAS you have the ability to take some money out of your insurer’s hands and control how much you set aside, where you save that money and what kind of interest it receives, and then choose how to spend it. All while receiving tax benefits for doing so.
At the same time, these plans aren’t for everyone. Your specific health coverage, deductible amount, and health care needs will ultimately dictate which plan is right for you. You’ll have to take a look at all of the variables in your situation and determine if an HAS is able to save you money or not.
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About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning Counselor® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.