If you're eligible for a health savings account , commonly called an HSA, taking advantage is a smart way to save money on your current and future medical expenses. These accounts were created in 2003 to give Americans tax breaks that reduce the cost of healthcare.
But in order to have an HSA, you must first be enrolled in a qualified health plan. Here's what you need to know about the benefits of using an HSA and how to qualify for one.
[See: How HSAs Can Help You Pay for a Wide Array of Health Services .]
Tax Benefits of a Health Savings Account
There are three main tax benefits you get when you use HSA funds to pay for qualified medical expenses .
Contributions are never taxed. Funds you put into an HSA can be claimed as a deduction on your taxes, even if you don't itemize them, or deducted from your paycheck on a pretax basis. You can make HSA contributions any time during the year, even up to April 15 for the previous tax year – but you're never required to make contributions.
You can contribute if you're retired, unemployed or have an annual income less than your contributions. You own your HSA at all times and can take it with you when you change medical plans, change jobs or retire.
For 2018, you can contribute up to $3,450 if you have insurance for just yourself or up to $6,900 if you have a family health plan. If you're over age 55, you can also contribute an additional $1,000.
Earnings are never taxed. Most HSAs pay interest on your balance, just like a bank savings account . Plus, you typically have the option to invest your balance in a menu of mutual funds.
Unlike with a taxable bank or brokerage account, interest and investment growth in an HSA is completely tax-free.
Withdrawals are never taxed. When you withdraw your original contributions and earnings from an HSA to pay for qualified health care expenses, you don't have to pay federal income taxes, state income taxes (in most states), Social Security or Medicare taxes.
Your funds can be spent on a variety of medical expenses that aren't covered by your health plan, such as your deductible, dental bills , vision expenses and prescription drugs. But withdrawals for nonqualified expenses, such as groceries or a vacation, are subject to income tax plus a 20 percent penalty. So never put money into an HSA that you might need for everyday expenses.
Your unused balance rolls over from year to year, making an HSA a convenient and easy way to save for future medical expenses. If you still have funds after age 65, your HSA can be used like a traditional retirement account where you pay income tax on withdrawals, but avoid the penalty.
[See: 10 Smart Ways to Spend Your Tax Refund .]
What Is a High-Deductible Health Plan?
While the benefits of an HSA can be substantial, not everyone can cash in. You can only have one when you also have a type of insurance known as a high-deductible health plan, commonly called an HDHP.
As the name indicates, an HDHP has a higher annual deductible compared to a traditional health plan. The upside is that they also come with lower monthly premiums.
HDHPs cover certain types of preventive care at no charge, such as an annual physical, prenatal and well-child care, immunizations and screenings, regardless of the deductible. That means those basic medical bills are automatically covered for you, even if you haven't met your annual deductible. So having a higher deductible doesn't necessarily mean that you have to skip important checkups if your budget is tight.
The annual premium savings and tax benefits can make an HDHP paired with an HSA very economical if you can afford the deductible. But if you have a chronic illness, take expensive prescription drugs or have children, you could end up paying more. So, carefully weigh having a potentially higher annual deductible against having guaranteed higher monthly premiums.
[Read: How to Negotiate Your Medical Bills .]
How to Know If Your Insurance is HSA-Qualified
For a health plan to be HSA-qualified, it must meet the following criteria for 2018:
If you're not sure if your health insurance makes you eligible for an HSA, read the policy for coverage details or contact your insurance company. If the insurer can't confirm that your plan is HSA-eligible, assume that it isn't.
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