Most people don't fully understand the tax advantages and other benefits Health Savings Accounts (HSAs) can offer. In this post, we’ll highlight oportunities to further enhance their values.
How do they work?
Think of an HSA as a 401(k) for medical expenses. Both employers and employees may contribute tax-free deposits but the account belongs to the employee. The balance rolls over from year to year—unlike “use-it-or-lose-it” flexible spending accounts (FSAs)—and the account can continue to grow through interest and investing. HSAs are administered by banks, insurance companies and other third-party custodians or trustees and in most cases, the HSA’s cash value is FDIC-insured. Unlike a 401(k), withdrawals from an HSA are tax-free as long as funds are used to pay for medical expenses.
Tax-free distributions from the HSA can help pay for health care expenses on behalf of employees, spouses and any dependents claimed on the employee’s tax return. Plus, under special HSA rules, an individual may be treated as a dependent for qualified medical expenses even if:
- The person filed a joint return.
- The person had a gross income of $4,000 or more.
- The employee or spouse, if filing jointly, can be claimed as a dependent on someone else’s return.1
Whether contributions to the HSA come from the employer, employee or both, these accounts can help employees manage the increasing costs of health insurance coverage.
The savings accumulated in HSAs are further enhanced by the built-in “triple tax advantage” HSAs enjoy from the IRS. In fact, HSAs are the most tax-advantaged product the IRS allows.
If funds are not currently needed for health care expenses, individuals can use these tax advantages to grow their account year-over-year for future use. After age 65, funds can even be used for non-medical purposes by paying only the income tax on their withdrawals.
On the other hand, many employees do not have the same capacity to allocate funds to their HSA. Funds contributed by the employer may be needed right away to assist with current health care costs not covered by the high-deductible health plan (HDHP).
The IRS permits certain supplemental insurance plans to help offset the increased financial risk employees face with HDHPs. These plans include “gap” coverage such as:
- Hospital indemnity plans: Inpatient only, no outpatient services covered.
- Specific disease policies: Including cancer and critical illness.
- Accident insurance: Catastrophic accident (AD&D) plans and indemnity plans that pay a fixed benefit for medical treatment after an accident.
Making the most of HSAs
Health savings accounts are complicated financial instruments, and these are only a few of the considerations that employers should understand before launching an HDHP with an HSA. But when properly structured and utilized, HSAs can offer significant savings advantages for employees—even beyond immediate health care needs.
To learn more about how HSAs can help your clients’ employees, read our Inside Track educational paper (PDF).