Health Savings Accounts Offer Tax Breaks
A Health Savings Account (HSA) is a trust account into which tax-deductible contributions can be made by qualified taxpayers who have high deductible medical insurance plans. Income earned on the HSA balance is tax-free. The funds from these accounts are then used to pay “qualified medical expenses” not covered by the medical insurance for an “eligible individual”. If these funds are not used, they roll over year to year. Once the taxpayer turns 65, the funds can be used like a retirement plan — taxable when withdrawn, but not subject to a withdrawal penalty — or saved for future medical expenses. Since the contribution is an above-the-line deduction, a taxpayer need not itemize to take advantage of this tax break on their federal income tax return.
- Eligible Individual – For HSA purposes the law defines an eligible individual as one who is covered by a “high deductible plan” and, while covered by that plan, is not also covered by another plan that does not have a high deductible. For purposes of determining if a plan does or does not have a high deductible, the law allows certain types of coverage, such as workers’ compensation, insurance for a specific condition, dental care, vision, long-term care and certain others, to be disregarded.
- High-Deductible Plans – For 2010, high deductible plans are defined as those with the following deductible amounts:
- Self-only coverage with an annual deductible of $1,200 (up from $1,150 in 2009) or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, of no more than $5,950 (up from $5,800 in 2009); or
- Family coverage with an annual deductible of $2,400 (up from $2,300 in 2009) or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, of no more than $11,900 (up from $11,600 in 2009).
- Qualified Medical Expenses – Qualified medical expenses that can be paid from these accounts are generally defined as those that would be allowable as a medical deduction on your tax return.
- Contribution Limits – The eligibility and contribution amounts for these accounts are determined monthly. Therefore, during any month in which you qualify, you would be entitled to contribute up to one-twelfth of the annual limits. For 2010, the annual limits (note these values are adjusted annually for inflation) are:
- $3,050 (up from $3,000 in 2009) for single coverage plans;
- $6,150 (up from $5,950 in 2009) for family coverage plans; and
- $1,000 (same as 2009) additional for individuals age 55 or older.
Example: John, a single taxpayer, age 58, begins a high deductible health plan with an annual deductible of $5,000 starting in March of 2010. We need to determine his maximum annual contribution limit, which is $4,050 ($3,050 plus $1,000 for being over 55). Next, we divide the annual limit by 12 to determine the monthly limit; in John’s case, it is $337.50 ($4,050/12). Since John was in a high deductible health plan for 10 months during 2010, his maximum contribution limit for 2010 would be $3,375.00 ($337.50 x 10.) If John were in the 25% tax bracket, he would realize a tax savings of $844.