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Thayer Partners Blog

What Is a Health Savings Account (HSA)?

[fa icon="calendar"] Mar 28, 2016 9:00:00 AM / by Chris Wilmerding

Chris Wilmerding

What_Is_a_Health_Savings_Account_HSA.jpgHealth savings accounts (HSAs) have become more popular in the US, particularly for taxpayers enrolled in high-deductible health plans. Essentially, these tax-advantaged accounts help people pay for eligible medical expenses until their high deductible is met, with funds that are free of federal income tax.

Their popularity has grown with employers due to the fact that premiums for high-deductible health plans are generally less than those for traditional health insurance. By increasing the deductible, they can reduce their premiums because the insurance carrier no longer has to pay for small, routine health care. Adding a health savings account to the high-deductible plan allows employers to offer affordable health insurance to their employees.

How Deposits and Withdrawals Work

The funds deposited into a health savings account can be made by a policy holder of the health plan, the employer, or another person. These deposits are made on a pre-tax basis through an employer, or on a post-tax basis to be used to decrease gross taxable income if the former option isn’t available through the employer. Pre-tax contributions aren’t subject to FICA or Medicare taxes. All sources of contributions count towards the annual maximum allowed, which in 2016 is $3,350 for single persons and $6,750 for families.

The funds that are deposited to a health savings account but go unused carry over to the next year. Even if you end your HSA-eligible insurance coverage, the funds you’ve accumulated remain available for use.

If you own a health savings account, you can withdraw funds at any time, without advance approval from your trustee or medical insurance, and if the withdrawals are made for qualified medical expenses, they’re not subjected to income taxation. And since there is no deadline for re-imbursement of these qualified medical expenses incurred since the HSA was established, participants can pay for medical costs out of pocket and retain receipts, allowing their accounts to grow tax-free until they choose to withdraw the funds later on, up to the value of the receipts.

Withdrawals that are made for a reason other than a documented qualified medical expense are subject to income taxes, however, as well as a 20% penalty, until you have reached the age of 65 or have become disabled.

Use as an Investment

Funds deposited into a health savings account can be invested in a similar manner as an individual retirement account (IRA) because the investment earnings are tax sheltered until the money is withdrawn. And just as IRAs, health savings accounts are self-directed, meaning you choose how you want the money invested. Investments usually include a handful of mutual funds or index funds.

HSAs vs FSAs vs HRAs

Health spending accounts are similar to flexible spending accounts (FSAs), with the main difference being that the funds accumulate and roll over year after year if they’re not spent, allowing the funds to be used for future health care tax-free or be used for retirement on a tax-deferred basis. They’re also similar to health reimbursement arrangements (HRAs), which are alternative tax-deductible sources of funds paid out by a company and typically paired with a high-deductible health plan. However, health savings accounts and flexible spending accounts are owned by an individual while HRAs are funded solely by a company and are used to reimburse employees for eligible health expenses.

The Larger Picture

A component of consumer-driven health care, HSAs are used to pay for qualified medical expenses, without federal penalties or tax liabilities. Proponents believe HSAs will help increase the health care system’s efficiency and reduce health care costs. They encourage users to save for future health care expenses, as the accumulated funds can be saved. They also encourage consumers to be more responsible for their health care choices, while also allowing them to receive whatever medical care they need, without any benefit exclusions or maximums set forth by an insurance carrier.

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Topics: Health Savings Account

Chris Wilmerding

Written by Chris Wilmerding

Chris Wilmerding is Principal of Thayer Partners, an independent investment management firm located in Westwood, MA providing financial planning and wealth management counsel to individuals and their families.

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