More and more people are looking into saving money in a health savings account. What are health savings account rules and how do they affect your taxes? We answer all your questions here.
Table of Contents
- 1 What Is A Health Savings Account?
- 2 Health Savings Account Rules
- 3 How Does A Health Savings Account Affect My Taxes?
- 4 Do I Have To Report HSA Contributions On My Tax Return?
- 5 Do HSA Contributions Reduce Your Taxable Income?
- 6 HSA Tax Deduction Calculator
- 7 Conclusion
What Is A Health Savings Account?
Established in 2003 as part of the Medicare Prescription Drug, Improvement and Modernization Act, a health savings account is offered to individuals who have a high deductible health plan or HDHP so that they may save for expenses not covered under their current health plans or may cost more than the current amount. The money you put in the account is the pre-tax money from your pay, so you don’t have to pay taxes on this part of your income. Unlike health insurance offered by employers, you can carry your HSA account as you switch jobs or switch health plans, and even when you retire.
Health Savings Account Rules
HSA Eligibility Rules
For starters, you need to have a high deductible health plan. What constitutes a high deductible health plan? In 2020, the IRS guidelines state that any plan with a minimum deductible of $1,400 for individuals and $2,800 for families fall under the category of an HDHP. The out of pocket maximums should be at least $6,900 for individuals and $13,800 for families. The out of pocket maximums include deductibles, copays, and coinsurance.
Additionally, you should
- Not be covered by your spouse’s medical plan,
- Not benefitting from medicare
- Not marked as a dependant on someone else’s tax returns
- Not availing benefits by the Veteran’s Administration
- Not be enrolled in alternative medical savings account like the Flexible Spending Account or the Health Reimbursement Account
- Not be a part of TRICARE or TRICARE for Life
If you meet the above criteria, and if your financial situation allows it, you can go for a health savings account.
HSA Contribution Rules
The amount of money you can add in an HSA has an annual cap on it. The amount can be added by you or your employee. The IRS has set the limit on the annual contributions that can be made to an HSA. In 2020, the maximum amount that can be contributed to an individual HSA is $3,550 and for family coverage, it is capped at $7,100. If you are 55 or older, you can have an extra $1,000 added per year as a catch-up amount.
HSA Withdrawing Rules
Just like the amount of money you can place in an HSA account, the amount of money you can withdraw from it also follows rules set by the IRS. Withdrawals from the HSA are tax-exempt if you use them for covering a qualified medical expense that is not covered by your pre-existing high deductible health plan. A qualified medical expense includes deductibles, dental services, vision care, prescription drugs, psychiatric treatments, and other medical expenses not covered by health insurance. Mostly, individuals use a debit card provided by the HSA to pay for their medical needs. If your total amount exceeds the funds you have available in the debit card, you may be able to call your HSA provider and have the excess amount billed to be paid later.
If you are above 65 years of age or have Medicare you may be able to use your HSA to pay for your insurance premiums.
How Does A Health Savings Account Affect My Taxes?
A health savings account affects your taxes in not one, but three different ways. With the government cutting taxes on everything – from your property to your income to even the lottery money (if you finally win any), a health savings account is like a phoenix; rising from the ashes of $3.5 trillion in taxes collected in 2019 alone.
The very first advantage is that HSA contributions are made on the pre-tax income. How does this affect your taxes? Well, when you get your entire pay, a part of it is deposited in the health savings account without any tax deductions. The rest of your income, known as the adjusted gross income (AGI), is now less than what you initially had. The government levies the income tax on the adjusted gross income, so with the AGI now lowered, your total taxes also decrease. Even if you make the contributions to your HSA account after paying your taxes, you can deduct them from your gross income when you file your tax returns, reducing your total taxes for the year.
You may be surprised to hear this but you can use your HSA funds for investment! And what’s more, the interest on the funds is completely tax-free. This is one of the most rewarding aspects of a health savings account. The money is carried over from one year to the next so your available funds for investment keep growing as there is no use-it-or-lose-it rule like in a Flexible Spending Account. Even the investment from an HSA is not tax-deductible. Hence, you have a parallel income that is completely tax-free and easy to manage, since most HSA providers partner with investment companies so you can manage everything from one place.
The third way that HSA affects your taxes is when it comes to withdrawing money. When you withdraw funds from the account for a valid medical expense, such as to pay your deductible, dental, or vision care, or to pay for prescriptions, you are exempt from paying federal income taxes. This holds true for federal income tax only, and states have their own rules for whether they treat an HSA as exempt from federal income tax or not. Check your state laws.
Do I Have To Report HSA Contributions On My Tax Return?
Americans report their tax return on Form 1040 every year. This form requires you to include your total income from all different sources, like Social Security, capital gains, salary, wages, etc. It is then used to determine whether additional taxes are owed by the filer or will they get a tax refund.
HSA contributions are reported every year as part of your tax returns but not on form 1040. To report any contributions to the HSA, whether, by yourself or your employer, you must file Form 8889 (Health Savings Account (HSAs)) as an attachment with Form 1040. Any distribution from the HSA should also be reported in the same form. If your spouse has made some contributions or taken some distributions from the HSA, he or she will have to file a separate Form 8889, even if the tax returns on form 1040 are filed by both of you together.
Form 8889 has some of its own requirements that need to be met. What information do you need to file your HSA contributions with your tax returns? We provide a list below of what needs to be put on Form 8889.
- Information about your HDHP coverage
- HSA contribution limit
- Amount of HSA contributions made by yourself or on your behalf. These are reported on Form 5498-SA and must be made available to you from your HSA provider so you can fill form 8889 with it.
- Amount of taxable or non-taxable HSA distributions taken out
- Contributions to HSAs by employers should be reported in Box 12 of Form W-2
- Amount of distributions, if any, taken out from an HSA. These are reported on Form 1099-SA, and you must receive it from your HSA provider for filling out Form 8889.
So in a nutshell, you have to report your health savings account on taxes by submitting an additional Form 8889 along with Form 1040 when you file your tax returns. You will also need Form 5498-SA and Form 1099-SA from your HSA custodian or trustee.
Do HSA Contributions Reduce Your Taxable Income?
The short answer? Yes, HSA contributions do reduce your taxable income. Since contributions are made pre-tax, the gross income adjusts to a lower amount. This means that the total income which is now taxable is reduced, thus directly reducing your taxes as well.
HSA Tax Deduction Calculator
An HSA tax deduction calculator shows you how much you are saving in taxes, your maximum contribution, and the withdrawal limit. You can use any of the calculators listed below:
- HealthEquity Health Contribution Calculator
- HSA Store’s HSA Tax Savings Calculator
- CareFirst HSA Contribution Calculator
- JP Morgan Chase HSA Calculator
- HSA Bank HSA Calculator
A health savings account is more than just a way to have savings to be used to cover expenses not covered by your high deductible health plan – it is also a way for you to save on taxes. You will have to file your HSA contributions on your tax returns on Form 8889 and submit it along with Form 1040.