HSAs, or health savings accounts, provide significant tax incentives to complement high-deductible health insurance plans. HSAs offer tax-deductible contributions, tax-free growth and, if used for medical expenses, tax-free withdrawals. Knowing how these plans work can help you make an informed decision about whether they are right for you.
Money in the Account
HSAs are tax-sheltered savings accounts, which means that as long as the money remains in the account, the interest on the investments is not taxed. This results in significant savings and helps the money in the account accumulate faster. For example, if you earned $500 in interest and you fall in the 28 percent tax bracket, you would save $140 in taxes. In addition, the following year, you have an extra $500 in the account to earn more interest instead of just $360 extra to earn interest.
Withdrawals from the Account
When you take the money out of the account, the interest is not taxable if the distribution is used for qualifying medical expenses. However, if you take money out of the account for non-qualifying expenses, the money is subject to income taxes and a 10 percent penalty. However, the 10 percent penalty is waived if you take the money out after you turn 65, enroll in Medicare or become permanently disabled.
Qualifying expenses include most medical, dental and vision treatments. Treatments can include preventative care, routine checkups and surgeries. You can also use the money for prescription drugs and insulin. However, nonprescription drugs are not considered qualifying expenses. Insurance premium payments are not permitted unless you make those payments while on unemployment, are paying for COBRA after leaving your employer, are paying for qualified long-term-care insurance or are paying for Medicare premiums.
Who Can Have an HSA?
HSAs can only be contributed to by people who have high-deductible health insurance plans. As of 2010, HDHPs refer to those with an individual deductible over $1,200 or a family plan with a deductible over $2,400. If you have one of these plans, you can contribute money each year and have it invested so it increases over time. As needed, you can take distributions from the account for your medical costs.