You can use a health savings account (HSA) to pay your medical expenses and decrease your tax burden. The funds in these accounts belong to the contributor, unlike medical insurance premiums, which, once paid, belong to the insurance company. Because of this, when you need the money, it is called a "distribution" instead of a "benefit."
Video of the Day
When you buy insurance, your premium payments pay for coverage in case "something bad" happens to you. Insurance companies use customer premiums to build cash reserves to fund claims. If something happens that qualifies you to receive the benefits you've paid for, the insurance company is obliged to pay those benefits, even if they far exceed what you have paid in premiums. If you never need to file a claim, you will not receive any benefits.
Health Savings Accounts
Health savings accounts differ from insurance in an important way. The money you place in these accounts still belongs to you. These funds are intended for a specific type of spending, and you are generally better off using them for medical expenses. However, it is still your money; while you may face tax repercussions or penalties, you can withdraw the money at any time. When you draw money from an HSA, you are only spending money that belongs to you. There is no entity, like an insurance company, that has additional funds to pay out, as an insurance company does if insurance benefits exceed what you pay in premiums.
When you withdraw money from an HSA, you are not claiming a benefit that is owed to you according to an insurance contract. Instead, you are moving money from one financial instrument that you control (the HSA) to your control outside that instrument (usually to pay medical bills or related expenses). This is why financial professionals use the word "distribution."
The word distribution was borrowed from its use with retirement accounts. Cash would accumulate in these accounts during a person's career. After retirement, the funds would be "spread out" in monthly payments to its owner. While medical expenses are not as regular and predictable as monthly bills, the way the accounts function is similar.
You do not have to pay taxes on contributions to your HSA, up to certain amounts. As of 2014, these sums are capped at $3,300 for an individual and $6,550 for a family. When you withdraw money from the HSA for medical expenses, you do not have to pay taxes on them then either. Related expenses, like travel or lodging, that are associated with getting treatment may also be authorized. Authorized withdrawals for medical treatment or related expenses are always tax-free. For authorization, be sure to speak with the administer of your plan and keep all your receipts.
If you remain so healthy that you never draw from your HSA for medical expenses, you can take distributions from it once you turn 65. You will have to pay taxes on these distributions, though. If you must withdraw the funds before then, you can take them for any reason, but you will have to pay both taxes and a 20 percent penalty.