Okay. You’ve decided to go the HSA route. You have found a decent high deductible health plan. You understand that because this is a tax-qualified plan, you will have to follow some rules (sorry!). Part of rules thing means that there are limits to how much you can contribute to your HSA each year and then write off on your taxes.
For calendar year 2011, the annual limit for an individual with the appropriate HDHP is $3,050; for an individual with family coverage, the limit is $6,150. These amounts are inflation-indexed, by the way, and increase every year at a rate determined by the IRS.
One way of looking at this is that the government is essentially ‘paying’ you to save your own money for medical expenses by allowing you to deduct 100% of your annual HSA contributions. And remember – these medical expenses may never happen! If you don’t use the money in that year, fine! Keep it and let it earn interest. In the meantime, you can contribute fully, 100%, the next year to your HSA and take the same deduction on that amount.
You cannot use the funds to pay premiums, as this would be considered a non-medical withdrawal and subject to taxes and penalty. There are some important exceptions, however: no penalty would apply if the money is withdrawn to pay for a qualified long-term care policy; or health insurance, including a qualified major medical plan, while you are receiving unemployment compensation or if you are entitled to COBRA or other health continuation plans. And now the funds can be used for Medicare premiums.
According to AMA statistics, the odds of the average American being hospitalized in any given year are about 1 in 12. This means it is very unlikely that you will meet your deductible every year. As you fully fund your HSA and the years go by, your tax-sheltered savings account keeps getting fatter and fatter! There is even a decent chance that, at some point, you will have saved more than you have paid out in premiums.
All the funds you deposit in your HSA are 100% tax-free as long as they stay there. Earnings on those funds are also free of taxes while in the account. At age 65, you have some other choices. You can leave the funds in the account to cover future medical expenses (and this would mean never paying taxes on the interest or principal), or you can start using the HSA as an IRA. After age 65, you will be taxed only on the funds you withdraw for non-medical usage – no more ‘early’ withdrawal penalties apply.
The IRS has some rules about other health coverage. As a rule, you (and spouse, if family coverage) cannot have any other health coverage that is not an HDHP. You can still be an eligible individual even if your spouse has a non-HDHP so long as you are not covered by that plan. You can also have coverage that provides only benefits for:
- Liabilities incurred under workers’ compensation laws, tort liabilities or liabilities related to ownership or use of property.
- A specific disease or illness.
- A fixed amount per day (or other period) of hospitalization.
- Dental care
- Vision care
- Long-term care