Health savings accounts could lower monthly expenses Tax Matters by David A. Katzman Nearly everyone is looking for ways to reduce their household budgets these days. The most common approaches include cutting vacation costs, eliminating luxury items, cooking at home or reducing other unnecessary monthly expenses. However, far fewer people consider the potential longer term savings they might achieve by lowering their healthcare costs. A health savings account (HSA) is one possible way to lower healthcare costs. However, you must meet certain criteria in order to establish one of these accounts. An HSA is a tax-advantaged account that allows you to pay for qualifying medical expenses from funds that have escaped federal taxation. Depending on your 2008 tax bracket, this could mean the Internal Revenue Service (IRS) is offering HSA owners up to a 35 percent discount on medical expenses. How do you qualify for an account? You must be covered by a “high deductible health plan.” Generally, self-employed individuals elect to use these types of plans. However, employers are increasingly offering high-deductible plans, often as an election in lieu of other lower-deductible plans, as well. Selecting a high-deductible plan generally means lower overall monthly medical insurance expenses, so it is worth weighing the benefits when used in combination with an HSA account. Qualifying high-deductible plans are specifically defined by the IRS. For 2009, plans must have an annual deductible of at least $1,150 for single coverage or at least $2,300 for family coverage. For families covered by two insurance plans, which is often the case for working couples, HSA eligibility requires that both plans be high-deductible plans. Additionally, the maximum amount of out-of-pocket expense limits for covered medical expenses, excluding insurance premiums, cannot exceed $5,800 for individuals or $11,600 for families. There are some insurance-coverage exemptions, such as separate coverage for accidents, disability, dental, vision or long-term care, which will not disqualify you for an HSA. The IRS also limits annual contributions to HSAs. In 2009, the maximum annual contribution is $3,000 for individuals and $5,950 for families. To make the maximum contribution, divide by 1/12 and pay that amount monthly. For individuals age 55 and over, an additional $1,000 “catch-up” contribution is allowed. Medicare recipients are not eligible for an HSA. Contributions may be made by you or by someone on your behalf, generally an employer. To maintain the tax-exempt nature of these contributions, employers must offer this benefit equally to all employees. If made by your employer, it is treated as an employer-provided coverage for medical expenses and is excluded from your wages up to the contribution limitation. If contributed by you as a sole proprietor, it will be a reduction of your income in arriving at adjusted gross income or if contributed by an employee at their election as part of a salary reduction arrangement that is part of a cafeteria plan, it will be treated as a reduction of taxable wages. Once money is deposited in an HSA, it may be invested and earn returns in a manner similar to an IRA or other retirement account. The earnings, if properly set up and withdrawn in accordance with plan rules, are also tax-exempt. Funds that are withdrawn for non-qualifying reasons are subject to ordinary income tax and a 10 percent penalty. After age 65 or in the event of death or disability, this penalty does not apply but taxes may be owed on withdrawals. If you have an established HSA but subsequently become ineligible to continue making contributions, you may still take tax-advantaged withdrawals for qualified medical expenses. However, you will not be able to make additional contributions. Until December 31, 2011, eligible taxpayers may also make one-time transfers from several types of accounts into an HSA. These accounts include a health flexible spending arrangement (health FSA) or a health reimbursement arrangement (HRA). This one-time transfer is limited to the lesser amount of the balance in these accounts on Sept. 21, 2006 or the balance on the transfer date. You may also make a one-time, penalty-free transfer from an IRA to an HSA through 2011. This transfer amount is limited to the maximum allowable annual HSA contribution. A tax professional can help you determine, based on your individual circumstances, if you could benefit from establishing an HSA. David A. Katzman is a certified public accountant licensed to practice in the State of Florida and the Commonwealth of Massachusetts. He is also a certified financial planner and certified senior advisor. Please consult your tax advisor for details and assistance in applying this general information to your specific situation.