How to Know If Your Health Plan Qualifies for an HSA

A health savings account or HSA is a type of tax-advantaged account that was created in 2003 to help Americans manage and reduce medical expenses. With rising healthcare costs, there’s a lot to love about HSAs—but also a lot to know.

I received a question from Money Girl listener Lydia G., who says, “My family owns a small business and we administer our health plan. It’s a PPO with copays and deductibles of $3,500 in network and a maximum out of pocket expense of $7,350. I would love to set up an HSA for myself and my spouse, who is also covered under our plan. How can I make sure that our health plan qualifies for an HSA?”

In this post I’ll answer Lydia’s important question and cover the facts about what an HSA is and the rules to qualify for one. If your health plan qualifies for an HSA, it’s one of my favorite ways to cut medical costs and save more money.

What Is an HSA?

First, let’s review what an HSA is and how it helps you save money. As I mentioned, it comes with tax advantages, specifically three benefits:

1. Your HSA contributions are never taxed.

An HSA is funded with pre-tax dollars, whether you make contributions or your employer does so on your behalf. If you fund the account on your own, you claim total annual contributions as a deduction on your taxes (even if you don’t itemize deductions). If an employer makes your contributions, they’re deducted from your paycheck before taxes are taken out.

You can make tax-deductible contributions to an HSA at any time during the year, even up to April 15 for the previous tax year. You can contribute even if you’re retired, unemployed, or have annual income less than your contributions. And you’re never required to make HSA contributions.

2. Your HSA earnings are never taxed.

Most HSAs pay interest on your balance, just like a bank savings account. Plus, you typically also have the option to transfer all or a portion of your HSA to investments, such as mutual funds, to grow your balance.

Unlike with a taxable bank or brokerage account, interest or investment growth in an HSA is completely tax free.

3. Your HSA withdrawals are never taxed.

When you take money out of an HSA, there are no taxes. This is true no matter if you withdraw original contributions, interest income, or investment earnings from the account to pay for qualified healthcare expenses.

The bottom line is that you don’t have to pay federal income tax, Social Security and Medicare tax, or state income taxes (in most states) on funds deposited into or withdrawn from the account. Your funds can be spent on a variety of medical expenses that aren’t covered by your health insurance, such as your deductible, dental bills, vision expenses, prescription drugs, and copays.

How Much Can You Contribute to an HSA?

There’s no requirement for HSA participants to make contributions, but there are annual caps. 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 plan. If you’re over age 55, you can also contribute an additional $1,000.

In many cases, employers also contribute HSA matching dollars when you enroll in a HDHP at work. If so, contributions from your company must be included in the annual limit. No matter if you get an HDHP on your own or through an employer, you're still eligible for an HSA.

Funds you don’t spend simply roll over from year to year, making an HSA a convenient and easy way to save for future medical expenses. You own your HSA at all times and can take it with you when you  change medical plans, change jobs, or retire.

While these benefits are amazing, not everyone can cash in. You can only have an HSA when you also have a type of insurance known as a high deductible health plan, which I’ll cover in a moment.

Additionally, you generally can’t have any other health coverage besides an HDHP, or be enrolled in Medicare. Also, you can’t be claimed as a dependent on someone else’s tax return.

The downside of an HSA is that spending any amount of it on non-qualified expenses, like groceries or a vacation, subjects you to income tax plus a 20% penalty on those amounts. So never put money into an HSA that you might need for everyday expenses.

Check out the long list of qualified medical costs you can pay for using an HSA in IRS Publication 502, Medical and Dental Expenses.

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What Is a High Deductible Health Plan (HDHP)?

As the name indicates, a high deductible health plan, or HDHP, has a higher annual deductible compared to a traditional health plan. The upside is that they also come with lower monthly premiums. The insurance costs less because it doesn’t start paying your medical bills until you’ve met a higher annual deductible.  

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 costs 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, tax benefits, and potential employer contributions can make a high deductible health plan paired with an HSA very economical. If you’re relatively healthy and don’t have many medical expenses, you’ll probably come out ahead.  

Remember that the purpose of having health insurance isn’t to cover every expense associated with a head cold—it’s to protect your finances against a devastating, expensive major medical condition.

Before opting for a high deductible health plan, be sure you can afford the deductible. If you fund an HSA on a consistent basis or have other emergency savings to tap, you probably can handle it.  

But an HDHP isn’t for everyone. If you’re managing a chronic illness, take expensive prescription drugs, or have children, you could end up paying more. So, you need to weigh having a potentially higher annual deductible against having guaranteed higher monthly premiums.

See also: 6 Tips to Find Affordable Health Insurance When You Become Self-Employed

How to Know If Your Health Plan Qualifies for an HSA

Now that you understand more about HDHPs, let’s get back to Lydia’s question about how to know if her health plan is HSA-qualified. It’s a little tricky because not all health plans with high deductibles are eligible.

For a health plan to be HSA-qualified, it must meet the following three criteria for 2018:

1. Minimum deductible – must be no less than $1,350 for individual plans and $2,700 for families.  
2. Maximum out-of-pocket – can’t exceed $6,650 for individuals and $13,300 for families.  
3. Benefit exclusions – restrict the services you can receive to preventive care only, before meeting the annual deductible. For a health plan to conform to the Affordable Care Act, it must cover a set of preventive services at no cost to you. For example, if a health plan pays for emergency services, doctor visits, or prescription drugs with a co-pay before you meet the deductible, it’s not HSA-qualified. Again, preventive care, such as getting a physical, cancer screenings, or immunizations, can be covered before you meet a deductible with an HSA-qualified plan.

Since Lydia mentioned that her husband is also covered, let’s compare her plan to the HDHP requirements for a family plan. Her insurance has a $3,500 deductible, which does meet the first criteria of being more than $2,700. Her plan also meets the second criteria, with a $7,350 out-of-pocket maximum compared to the required $13,300 limit.

But we don’t know if Lydia’s plan meets the third criteria for benefit exclusions. She would have to read her policy for the coverage details. Also look for a reference to Internal Revenue Code Section 223, which is the law that defines the HDHP rules.

When in doubt, contact your insurance company. Since being a qualified HDHP is a big selling point for insurers, most aren’t shy about labeling eligible plans as HSA-qualified.

But Lydia mentioned in her email to me that she did contact her insurer and still didn’t get a clear answer. My recommendation is to call the insurer again and ask to speak to a policy specialist or a manager.

If an insurer can’t confirm that your plan is HSA-eligible, I’d assume that it isn’t. When open enrollment comes up for Lydia’s company, they should shop quotes for a bonified, HSA-qualified plan.

To quickly review the health savings account rules and the best places to get an HSA, download the free HSA Cheat Sheet. This one-page reference explains the requirements and rules you need to know.

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What Happens to an HSA When You No Longer Qualify

A common question that comes up is what happens to an HSA balance if you become uninsured or switch to a non-qualified plan. The good news is that you can still use the money in your HSA to pay for medical expenses tax-free. However, you won’t be eligible to make any new contributions if you’re not covered by an HSA-qualified plan.

If you still have funds in an HSA after you turn 65 it morphs into something very similar to a retirement account. You can use the money for non-medical expenses without the steep 20% penalty, but still must pay income tax on those amounts.

How to Fund Your First HSA

You may be thinking that having an HSA sounds great, but where would you get the extra money to fund it? That brings me to one of the HSA’s best features: You can make a once-in-a-lifetime transfer from your IRA to fund an HSA without paying an early withdrawal penalty. That’s how I opened my HSA years ago.

7 Major Benefits of an HSA

To sum up, here are seven major benefits of an HSA:

1. Contributions to an HSA are tax deductible up to the annual legal limit. That means you reduce your taxable income and the amount of tax you have to pay by funding the account.
2. You never lose HSA funds because they stay in the account from year to year for your entire life, with no penalty if you don’t spend them.
3. Withdrawals from an HSA are never taxed as long as you spend them on qualified medical expenses.
4. Contributions grow tax-free when you have interest earnings or investment gains in an HSA, if you spend them on qualified medical expenses now or in retirement.
5. You can spend an HSA on you, your family, or your dependents when there are qualified, out-of-pocket, medical expenses.
6. You own an HSA and can decide how much to save or spend each year. It’s yours no matter if you change employers, switch health plans, become unemployed, or retire.
7. If you no longer have an HDHP you can’t continue making contributions, however, you can always spend it on qualified expenses.

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