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Setting Up and Using a Health Savings Account (HSA): Eligibility, Tax Advantages, and Reimbursement

written by: Patricia Tokar, CPA•edited by: Jason C. Chavis•updated: 7/26/2011

The Health Savings Account (HSA) is an individual tax-advantaged savings account designed to allow you to save for and pay your medical bills. This article covers determining if you are eligible for an HSA, HSA rules, how to select an administrator, contribution limits and deadlines, and how to report the HSA on your personal tax return.

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    What is a Health Savings Account?

    The Health Savings Account (HSA) is a tax-advantaged plan intended to be used by individuals for covering medical expenses. Simply stated, it is a savings account that is designed to allow you to save for and pay your medical bills. Money deposited to this account creates a tax deduction on your Federal (and probably State) tax return. You maintain ownership and control of the account. You pay your qualified medical bills with a check or debit card from this account. Unused amounts remain in your account for use in future years, even remaining for use in retirement. This is a big advantage of the health savings account, because you can feel comfortable contributing the maximum allowable without fear of losing any amounts that you have not used by the end of the year.

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    The Four Basic Requirements for HSA Eligibility

    There are four basic requirements that must be met:

    1. Before you can open an HSA, you must have a health insurance plan that has a high deductible, called a High Deductible Health Plan (HDHP). The HDHP must follow the IRS guidelines for both the deductible amount and the maximum out-of-pocket amount. The qualifying deductible guidelines are:

      • Minimum deductible - Single Coverage - 2011 $1,200
      • Minimum deductible - Family Coverage - 2011 $2,400
      • Maximum Out-of-Pocket - Single Coverage - 2011 $5,950
      • Maximum Out-of-Pocket - Family Coverage - 2011 $11,900
      • (out of pocket includes co-pays and deductibles)
      • Note that the minimum deductible and maximum out-of-pocket amounts for 2011 are the same as 2010

    Your health insurance provider will be able to tell you if the plan you are purchasing will qualify for a HSA. In fact, many providers will have plans specifically labeled as HSA qualified plans.

    2. You cannot have any other health coverage other than the HDHP

    3. You cannot be claimed as a dependent on someone else’s tax return.

    4. You cannot be covered by Medicare.

    Once you have determined that you have met the requirements above, you are ready to set up your HSA.

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    Choosing and Opening an Account

    Bank 

    • Choose where you will deposit and maintain your HSA account. Your HSA must be maintained by a qualified third party, such as a bank, credit union, or savings and loan. It does not have to be selected by your health insurance provider.
    • Review the monthly/yearly service fees. Compare these rates. They tend to range from $2.50/ month to $15.00/month. A few will have no service charges.
    • Additionally, determine how much interest or investment income your account will make. These tend to range from .5%- 4.5% annualized return.
    • Finally, determine how you will withdraw from the account. Most HSA accounts simply issue a checkbook and a debit card and you will be in complete control of what medical expenses are reimbursed or direct paid. Less often, the account will be set up so that you submit your receipts and then receive a reimbursement check from your account.

    Ideally you will choose based on low fees, good investment rates, and convenience.

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    Making Deposits - Yearly Limits and Deadlines

    Cash 

    Deposit your funds, noting the limitations below. For the most part, the deposit must be in cash (or check), unless you are rolling over funds from another HSA (or possibly from your flexible spending account).

    • Limitations on yearly deposits:
    • 2011 - Single coverage $3,050.00
    • 2011 - Family coverage $6,150.00
    • You may contribute an additional $1000.00 if you are 55 or over by 12/31/2011
    • Keep track of your deposits. The amounts deposited will be tax deductible, whether you use the amounts for reimbursement or just leave it in the account.
    • Deposits must be made by April 15th of the following year. For example, 2011 deposits can be made up to April 15, 2012.
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    Pay Your Medical Bills

    Reimburse or pay your medical expenses

    • Determine what is eligible: This includes qualified medical expenses for yourself, spouse, and dependents only to the extent not covered by health insurance.
    • Note that the definition of qualified medical expense for over-the-counter medicines has changed for 2011. Prior to 2011, qualified medical expenses could include many over-the-counter items. For qualified medical expenses after 2010, an over-the-counter medicine is considered qualified only if your doctor writes a prescription for it. Insulin is an excepton and will still be a qualified medical expense for 2011.
    • The expense must be for a specific, non-cosmetic medical treatment that cures or alleviates an illness, injury, or congenital birth defect. This may include prescription drugs, doctor visits, hospital stays, lab tests, and such. Many drugstores will flag their eligible items on the cash register receipt. If the expense would qualify as an itemized medical deduction, then it will qualify as a qualified medical expense for purposes of your HSA. Refer to Publication 502 for more detailed information on deductible medical expenses. Also use IRC section 213(d) and Publication 969 as a guideline of qualified medical expenses.
    • Remember that the tax deduction is the amount of the deposits (contributions) and is not affected by whether you use it or not. If you have plentiful regular funds to pay your out-of-pocket medical bills, then consider just leaving the HSA money alone and letting it earn tax-free income. Then use the HSA account in later years for medical expenses or after you have retired.
    • Keep very careful track of the expenses reimbursed. Keep the receipts. It will be up to you to prove that the amounts you withdraw are qualified medical expenses. Withdrawals for qualified medical expenses are not taxable. If you withdraw money for non-qualified medical expenses or for other reasons, you will pay a 20% penalty (up from 10% in 2010) in addition to paying income tax on the non-qualified amount withdrawn. Exceptions are if you have reached age 65 or withdraw due to death or disability.

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    Report Your HSA Activity on Your Tax Return

    Use the simple reporting forms when you file your tax return (Form 1040)

    • You will receive two forms from your account administrator: A Form 1099-SA which reports how much you withdrew (distributed) from your HSA. The administrator must mail this by Jan 31. You will also receive a 5498-SA that states how much you deposited (contributed) to the HSA in the given year. The mailing deadline for the 5498-SA is May 15, so it is important that you have your own records of what you contributed if you want to file your return by April 15.
    • Fill out and attach Form 8889 to your 1040 tax return to report your contributions and withdrawals to the IRS. Deduct the amount of your allowable 2011 contributions on the front of your Form 1040, in the Adjusted Gross Income section.

    This is one of the main benefits of the HSA since most tax filers do not have enough medical expenses to exceed the minimum to claim them on the Schedule A. (On the Schedule A, only the medical amounts that exceed 7.5% of adjusted gross income are deductible.) In contrast, the HSA contributions are claimed in full on the front of the return.

    • Remember that any expense that has been reimbursed by your HSA cannot also be deducted as a medical expense on your Schedule A.
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    Disclaimers

    This article is not intended to be specific tax advice. It is intended as a general guideline only. Any specific advice should be sought from your tax professional.

    CIRCULAR 230 DISCLOSURE: Pursuant to Treasury Department guidelines, any federal tax information contained in this article, or any attachment, does not constitute a formal tax opinion. Accordingly, any federal tax advice contained in this communication, or any attachment, is not intended or written to be used, and cannot be used, by you or any other recipient for the purpose of avoiding penalties