Health Savings Account (HSA) Overview

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General Characteristics of HSAs

Health Savings Accounts (HSAs), introduced in 2004, have become a broadly adopted method for financing health care. The reason: HSAs usually provide a better way to minimize overall health care expenditures.

Here we present HSA overview and commentary which we hope to be easy-to-understand. For more in-depth (and less easy-to-understand) HSA information we recommend the most recent IRS publication on the subject.

HSAs will continue to exist under full implementation of the Patient Protection and Affordable Care Act and the Health Care and Education Affordability Reconciliation Act of 2010 (ObamaCare).

Two Components to HSA Package

The savings account component is optional. When you enroll in a HSA-compatible high deductible health plan you are not required to establish the savings account. However, you cannot establish the savings account or make additional contributions into an established savings account unless you are enrolled in a HSA-compatible high deductible plan.

Tax Advantages

Your deposits to a Health Savings Account (HSA) reduce your taxable income, and withdrawals, as long as the funds are used to pay qualified HSA expenses (defined by the IRS), are never taxed. In other words, HSAs allow you to fund out-of-pocket health care expenses with pre-tax money.

Unused HSA funds are yours to keep and these funds can remain in your account, without tax consequence, for as long as you live. Unlike some other tax-favored health plans, HSAs are not a "use it or lose it" proposition. As long as you are enrolled in a HSA-compatible health plan, you can make tax-advantaged HSA deposits until age 65.

HSA Funding Limits

The maximum you may contribute to a Health Savings Account (HSA) is:

If you are age 55+ and enrolled in an HSA-compatible health, you can make additional annual contributions of up to $1000. If your spouse is also 55 or older, you can make total additional family HSA contribution of up to $2000.

HSA Tradeoffs and Advantages

For the majority of consumers, HSAs produce a net financial gain. But there is a tradeoff: You will likely have less generous health insurance benefits.

With an HSA you will likely have a higher major medical deductible and you will not enjoy office visit and prescription co-pay benefits typical of PPO and HMO plans. Your potential out-of-pocket health care expenses may increase.

Changing How We Buy Health Care

HSAs are designed to motivate better health care purchasing decisions. The underlying idea is that people make smarter financial choices when they are spending their own funds -- with the extra motivation of the money otherwise growing in a tax-advantaged account.

To make better health care purchasing decisions you need better preliminary information about health care expenses. This issue of "cost transparency" is a key element of the health insurance industry's Consumer Directed Health Care (CDHC) movement. With increasing online access to hospital/physician fee data, more useful information is becoming available, but health care cost transparency is still in its early stages.

Retirement Savings vs Current Expenditures

You can treat your HSA as a pure retirement account, like an IRA or a 401k. You can make HSA deposits to age 65, never make a withdrawal and generate tax-deferred investment income to be disbursed in your retirement years.

However, a more financially sensible approach is to use some HSA funds for current health care expenses. It is a matter of paying bills with pre-tax income, as opposed to paying with after-tax income.

Use your HSA to save, but spend when appropriate. For most people the HSA functions both as a tax-deferred retirement account AND as a tax-advantaged health care funding tool.

How High a Deductible?

The higher your HSA-compatible plan deductible, the lower your health insurance premium.

In 2012 you can get a HSA annual deductible as low as $1200/single or $2400/family, but the most popular choices are HSA-compatible plans near the maximum annual HSA out-of-pocket (deductibles and copayments but not premiums) limits. In 2012 these amounts are $6050/single and $12,100/family. They will increase in 2013.

As your HSA balance grows, you may be inclined to purchase a higher deductible and further reduce your health insurance premium. Many of our clients purchase HSA deductibles in the vicinity of $5000/single and $10,000/family.

Are HSAs Right for You?

If you are not already enrolled in an HSA, you should give it serious consideration.

Over the years we have evaluated countless health insurance situations, leading us to this general conclusion: HSAs usually provide a significant financial upside, but a comparatively small (if any) financial downside.