Tax Advantages of a Health Savings Account

Health savings accounts (HSAs) have been around for nearly two decades, but many people are unfamiliar with them and the benefits they offer. This article is an overview of how they work, who is eligible for them, and what tax advantages they provide.

An HSA is essentially an interest-bearing, medical savings account that you can use to pay or reimburse certain medical expenses that you incur. Such qualified medical expenses may include (but are not limited to): diagnosis, cure, mitigation, treatment, or prevention of disease; prescribed medications; transportation primarily for and essential to medical care; and certain lodging away from home treated as paid for medical care.

You can set up an HSA on your own in much the same way you would establish an individual retirement account or a traditional savings account. You can open your HSA with a lump-sum payment or arrange to contribute on a regular basis. Any money you don't spend during the year is rolled over for subsequent years. If you are in good health, it's reasonable to assume that you could accrue a good-sized balance in your HSA over the years.

Eligibility Requirements

To be eligible for an HSA, you must be covered by a qualifying "high-deductible health plan." Only limited types of additional coverage are permitted, such as coverage for dental and vision care. You may not be enrolled in Medicare. The Big Advantage -- Tax Savings

There are several valuable tax-related benefits to having an HSA:

• You can claim a tax deduction on your federal income tax return for contributions you (or someone other than your employer) make to your HSA.
• Contributions to your HSA made by your employer (including those made through a cafeteria plan) may be excluded from your gross income.
• The contributions remain in your account until you use them.
• The interest or any other earnings on the account assets accumulate tax free.
• Distributions you receive from the account to pay qualified medical expenses are tax free.
• An HSA is portable, which allows it to stay with you if you change employers or leave the workforce.

Your HSA Balance as a Legacy

Your choice of an HSA beneficiary is important. If you pass away and the beneficiary is your spouse, then the account is treated as your spouse's HSA and your spouse can take tax-free distributions for qualified medical expenses. Basically, the tax-free status of the account continues. If the beneficiary is not your spouse, then the account stops being an HSA and the fair market value of the account becomes taxable to that beneficiary in the year of your death. If your estate is listed as the HSA beneficiary, then the value of the account is included on your final income tax return.

If you meet the eligibility requirements, a health savings account can be a useful tool in your financial planning toolbox. A financial professional can help you look into whether an HSA makes sense for your situation.