Health Savings Accounts: A Good Alternative for Some

If you have to pay your own health insurance, you should consider setting up an HSA.

If you have to pay for your own health insurance, you should think about establishing a health savings account (HSA). If you act before the end of December 1, you can get a big tax deduction.

An HSA is like an IRA for health expenses. You establish a Health Savings Account with a health insurance company, bank, or other financial institution. Your contributions to the account are tax deductible, and you don’t have to pay tax on the interest or other money you earn on the money in your account. You can withdraw the money in your HSA to pay almost any kind of health-related expense, and you don’t have to pay any tax on these withdrawals.

In case you or a family member gets really sick, you must also obtain a health insurance policy with a high deductible—for 2017 and 2016, at least $1,300 for individuals and $2,600 for families. The money in your HSA can be used to pay this large deductible and any copayments you’re required to make.

Using an HSA can save you money in two ways:

  • You’ll get a tax deduction for the money you deposit in your account.
  • The premiums for your high-deductible health insurance policy may be lower than those for traditional comprehensive coverage policies or HMO coverage (perhaps as much as 40% lower).

To participate in the HSA program, you need two things:

  • a high-deductible health plan that qualifies under the HSA rules, and
  • an HSA account.

HSA-Qualified Plans

You can’t have an HSA if you’re covered by health insurance other than a high-deductible HSA plan—for example, if your spouse has family coverage for you from his or her job. So you may have to change your existing coverage. However, you may get your own HSA if you are not covered by your spouse’s health insurance. In addition, people eligible to receive Medicare may not participate in the HSA program.

You need to obtain a bare-bones health plan that meets the HSA criteria (is “HSA-qualified”). You may obtain coverage from a health maintenance organization, preferred provider organization, or traditional plan.

HSA Account

Once you have an HSA-qualified health insurance policy, you may open your HSA account. An HSA must be established with a trustee. The HSA trustee keeps track of your deposits and withdrawals, produces annual statements, and reports your HSA deposits to the IRS.

Any person, insurance company, bank, or financial institution already approved by the IRS to be a trustee or custodian of an IRA is approved automatically to serve as an HSA trustee. Others may apply for approval under IRS procedures for HSAs.

Making Contributions to Your HSA

When you have your HSA-qualified health plan and HSA account, you can start making contributions to your account. There is no minimum amount you are required to contribute each year; you may contribute nothing if you wish. There are maximum limits on how much you may contribute each year:

  • If you have individual coverage, the maximum you may contribute to your HSA is $3,400 (2017) ($3,350 2016).
  • If you have family coverage, the maximum you may contribute to your HSA each year is $6,750 (2017 and 2016).

These maximums are adjusted for inflation each year. Individuals who are 55 to 65 years old can make additional optional tax-free catch-up contributions to their HSA accounts of up to $1,000.

Deducting Your HSA Contributions

The amounts contributed each year to HSA accounts, up to the annual limit, are deductible from federal income taxes. You can deduct HSA contributions made with your personal funds as a personal deduction on the first page of your IRS Form 1040. You deduct the amount from your gross income, just like a business deduction. This means you get the full deduction whether or not you itemize your personal deductions.

Last Month Rule

Under the last-month rule, you are treated as having the same high-deductible HSA coverage for the entire year as you had on or before December 1st of any year. This means that as long as you act by December 1, you may contribute and deduct the maximum amount for the entire year, even though you only had your HSA for a few weeks that year. This can give you a big tax deduction for the year --as much as $3,400 (2017) for individuals and $6,750 for families (you can add $1,000 more if you're over 55 by the end of the year).

However, you must keep your HSA coverage until December 31 of the following calendar year. If you don't remain covered during this “testing period,” the difference between the amount your actually contributed and the pro-rated amount that would have been allowed without the last-month rule must be included in your income and will be subject to a 10% penalty tax.

To learn more about deducting medical expenses, see Nolo's Medical Deductions page. Check the IRS website for current annual limits.

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