Health Savings Account (HSA): Debunking the Myths

Posted in: Employee Benefits

There are a lot of myths and misconceptions about Health Savings Accounts (HSAs), which is unfortunate because of the unparalleled benefits of this type of account. I work with hundreds of organizations, helping them to build employee benefits plans, and confusion often arises when discussing HSAs. To cut through the confusion, I’m going to outline the facts and debunk the common myths about who may have an HSA and the greatest benefits of having one.

The first important thing to understand about HSAs is the criteria an individual must meet to be eligible to open and contribute to an HSA.  There are basically three requirements for HSA eligibility:

  1. The account owner must be enrolled in a High Deductible Qualified Health Plan (QHDHP)
  2. The account holder cannot be taken as a dependent deduction on someone else’s tax return.
  3. The account holder cannot have, participate in or be eligible for claims under any other public or private health benefit.  This includes benefits such as (non-QHDHP) commercial insurance, Flexible Spending Account (FSA) or Health Reimbursement Arrangement (HRA) or Medicare.

Now that we are clear on the criteria for being eligible for an HSA, let’s discuss the many benefits of a Health Savings Account.

With an HSA, you may:

  • Receive a tax deduction for making contributions or contribute on a pre-tax basis from payroll if your employer allows it.
  • Earn accumulation in the HSA for interest or investment growth without paying annual taxes.
  • Save, invest and accumulate funds year over year.  There is no “use it or lose it” provision like in an employer Flexible Spending Arrangement (FSA).  There is also no cap on accumulations or growth making it a great supplement to retirement.
  • Keep your HSA even if you change jobs, change your medical coverage, become unemployed, move to another state or change your marital status.
  • Not be subjected to imposed income limits to qualify.
  • Increase or decrease funding amounts at any time as long as you don’t exceed the US Treasury Department’s annual contribution limits. For 2013, the annual contribution limits are:
    • With dependents enrolled in the QHDHP              $6,450
    • Without dependents enrolled in the QHDHP       $3,250
    • Over age 55 catch-up option                                      Additional $1,000 per year
  • Use the accumulated dollars to purchase anything you would like after you reach the retirement age of 65. These purchases are taxable at Ordinary Income rates like an IRA or 401k.

In many ways, a Health Savings Account has similar benefits to a qualified retirement plan, but may actually be better because:

  • They also allow you to access money from the account at any time to pay for qualified expenses on a tax-favored basis;
  • The money you withdrawal for qualified expenses is 100% tax free – no retirement plan can offer this;
  • Once you reach age 65, you can access the money to pay for non-qualified expenses.

Myths Associated with HSAs:

  • Myth: An HSA is directly related or tied to a health insurance plan.

FALSE: While an HSA holder must be enrolled in a QHDHP, the HSA has no other relation to a health insurance plan.  The HSA is simply a type of tax-favored investment or savings account independent of any QHDHP.

  • Myth:  HSAs are joint accounts owned by an individual and their spouse.

FALSE:  HSAs are never owned by more than one person, even though the money in an individual’s HSA may be used to pay for the qualified expenses of the HSA holder’s legal dependents or spouse. Those dependents or spouse do not need to be enrolled in the HSA holder’s QHDHP.

  • Myth:  Money in an HSA can only be used for medical expenses.

FALSE: HSA dollars may be used for more than just medical expenses.  Current regulations allow HSA dollars that remain in the account at age 65, to be used for absolutely anything, just like an IRA or 401(k). Distributions after age 65 are subject to ordinary income taxes – again, just like an IRA or 401(k) – but the HSA holder may take distributions any time after the account is established for most medical, dental and vision-related expenses that were incurred after the HSA was opened.  This could include things like eye glasses or contact lenses, orthodontia for children, or deductible, co-pay, or coinsurance expenses under the QHDHP.  Qualified distributions may also include some insurance premiums like COBRA, Medicare and Long-Term Care.   Distributions for qualifying expenses are never taxed*.

  • Myth:  I earn too much or own my own business, so I may not have an HSA.

FALSE:  There are no income limits for HSA eligibility, and anyone who meets the three criteria for having an HSA may have all of the benefits, even business owners.

  • Myth:  I can’t keep my HSA if I am no longer enrolled in a QHDHP.

FALSE:  While one’s ability to continue making tax-favored contributions is dependent on their enrollment in a QHDHP, keeping the HSA and getting the benefits of taking distributions lasts until the money is spent, even if no longer enrolled in a QHDHP.

  • MythAn HSA can only be offered through employers along with a QHDHP.

FALSE:  HSAs are owned by individuals and never businesses or employers.  Remember, eligibility to have an HSA has nothing to do with employment.  While it is true that many employers incorporate HSAs in their employee benefit programs; that is done only when employers decide to contribute to their employees’ HSAs or allow employees to make contributions to their own HSAs under a pre-tax payroll deduction.

Under current law, employers have the option to contribute to their employees’ HSAs. Employer contributions are completely tax free to the employee.

Employers with Cafeteria Plans may also allow their employees to voluntarily reduce their taxable earnings and have the employer deposit the reduced earnings directly into the employee’s HSA.  This results in less taxes coming out of the employee’s paycheck and saves the employee from having to take a deduction on his/her tax return at year end.

The most important takeaway is that Health Savings Accounts offer benefits that no other savings account can offer.  It may be among the single best opportunities for tax savings in the entire Internal Revenue Code.  Nowhere else can an individual make a tax deductible savings contribution, get tax favored accumulations and then acquire a tax-free distribution…..nowhere!

And as life expectancy has nearly doubled in the past century, health care costs grow at double-digit rates and tax rates soar, the HSA may actually be your single best savings opportunity.  Unlike the other things we save for in retirement like beach houses, automobiles and vacations, healthcare expenses are practically guaranteed. If you have any questions about HSAs, please click here for an informational HSA guide and/or feel free to contact me at jgreif@psafinancial.com.

Disclosure Information
* Tax penalties could be incurred for nonmedical expenditures if you are under the age of 65.
HSA’s are coupled with high-deductible health plans that may have higher out-of-pocket costs than other health plans.

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