What is an HSA?
An HSA is essentially a personal savings account reserved just for qualified health expenses. With an HSA, you can include medical expenses you pay for yourself and those you pay for your spouse or dependent. Qualified expenses include a wide range of medical and dental expenses, from the costs of acupuncture services to medical body spans and ambulance fees. For a comprehensive overview of what the IRS considers to be a qualified health expense, check out IRS Publication 502, Medical and Dental Expenses.
Eligibility Requirements for a Health Spending Account
To be eligible for the HSA deduction, you must be covered by a High Deductible Health Plan (HDHP) and not be covered under any non HDHP plan, e.g. an HMO or PPO plan. Further, your HDHP must meet certain requirements. For example, in 2019, your deductible must be at least the annual limit of $1,350 ($2,700 for family coverage) and your max out of pocket expenses are limited to $6,750 ($13,500 for family coverage). You also cannot be claimed as a dependent on someone else's return or be enrolled in Medicare.
There is a cap on how much you can contribute to your HSA, and it tends to change from year to year. In 2019, for example, self-employed individuals can contribute up to $3,500 ($7,000 if family) to their HSA. If you’re 50 or older, you can contribute an extra $1,000 to your HSA. If you’re uncertain about the limits, ask a trusted financial advisor.
Benefits of a Health Spending Account
There are a variety of benefits of opening a health spending account:
- Contributions to your HSA are tax- deductible. Generally they are pre-tax (assuming they come from your employer via payroll deductions), so they are not included in your gross income and are therefore not subject to federal income taxes. Plus, in most states, HSA’s are not subject to state income taxes (*There are some exceptions, which we will discuss.).
- Interest is tax free
- A variety of individuals can contribute, including your employer or relative or anyone who wishes to contribute.
- An HSA is completely portable, meaning even if you change jobs, get a new health insurance plan, move to a different state or retire, that money will still be yours to use when needed
- You can withdraw money from your account for medical purposes without any tax penalties.
- Once you’re 65 years old, nonmedical withdrawals are taxed at your current tax rate (If you’re 64 or younger, you’ll owe taxes as well as a 20% penalty).
How to Maximize Your HSA Deduction for 2019
If you’re looking to maximize your HSA deductions, you should start by contributing as much as the law allows every year. Since any interest accrued in your HSA is not taxed, it’s also wise to leave money in your HSA alone as long as possible. Lastly, it’s wise to shop around for HSA’s; not all plans are created equal. For example, some have lower fees than others, so those plans will obviously help you save more in the long run.
How Does Taxation of HSAs Differ by State?
It’s important to know that HSAs are taxed differently in different states. For example, right now, neither New Jersey nor California permit you to deduct your HSA contributions, and they also tax earnings and capital gains within HSAs. Make sure to ask your accountant or financial advisor for the tax rules on HSA’s in your state of residence
How to Claim the HSA Tax Deduction
Taking the HSA tax deduction is relatively easy. To take advantage of the HSA deduction, all you need to do is complete Form 8889 and then deduct qualifying amounts on Form 1040.
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