Tax Tips
HSAs: New Kid on the Health Savings Block - May 2006
Richard Scrivanich - Partner
If you have high annual deductibles on your health insurance, opening a health savings account (HSA) may be the best way to cover those costs while gaining tax benefits. You receive can “above-the-line” deduction for contributions made to your HSA, and the deduction rates have risen slightly from 2004. HSAs are a relatively new health savings vehicle; they have only been available since January 1, 2004, as a result of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003.
HSA eligibility
HSAs are available to anyone who is not eligible for Medicare and is covered by a “high deductible” health insurance policy–one with an annual deductible of at least $1,000 for individual coverage or $2,000 for family coverage. To be eligible to open an HSA, you must not be eligible for Medicare. Additionally, the high-deductible policy must be your only health insurance, with limited exceptions for (1) individuals who participate in certain flexible or reimbursement arrangements; and (2) those who have a qualifying separate plan for prescription drug benefits. There are no income limits that affect your HSA eligibility, but you may not receive all the tax benefits HSAs offer if you do not file a federal income tax return. Finally, you cannot be claimed as a dependent on someone else’s tax return.
Benefits of opening an HSA
Your HSA contributions are deductible “above the line,” meaning you can reduce your taxable income without itemizing. Unlike other tax-favored health plans, you are not required to spend all of the money in your HSA by the end of the year. Better still, the interest and investment earnings in the HSA are not taxable, allowing unused contributions to grow tax-free. Employer contributions to your HSA through a cafeteria plan are also excluded from income. You may take tax-free distributions from your HSA as long as you use the money to pay for “qualified” medical expenses. Please call our office to discuss which items and services are “qualified.”
Another benefit is that your HSA is portable, allowing you to take it with you to a new job. Contributions to an HSA must be made in cash (that is, not with stocks or other property) and can be made through April 15, 2006 for the 2005 tax year.
And HSA rules are forgiving. For example, if you accidentally take an HSA distribution to cover an expense that you reasonably believe is qualified medical expense to only later learn that you were mistaken about whether the expense was qualified, you can replace the funds by April 15 of the year following the distribution to steer clear of being taxed on the amount you withdrew in error.
2005 HSA deduction rates
The maximum deduction for contributions to a health savings account has risen for tax year 2005 to the lower of your insurance policy’s deductible or $5,250 for a family plan and $2,650 for an individual plan (up from $5,150 and $2,600 in 2004). Individuals aged 55 and older may deduct an additional $600 bringing the total deduction to $5,850 for family coverage and $3,150 for individual coverage.
If you have any questions regarding HSA (health savings account) or any other tax matter, please feel free to give me a call at (562) 698-9891.
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