By Noah Styles, CPA

According to a 2018 America’s Health Insurance Plan article,[1] 22 million Americans have a Health Savings Account (HSA).  Why so many?  Well, HSAs have a unique triple tax incentive.  If you are like the average person, when you hear the term triple tax incentive, you start hearing sleigh bells, and feel a slight shiver of excitement run down your spine, wondering for a couple of seconds if it is Christmas Eve!

In this article, we will examine various questions Americans ask about HSAs.  “What is an HSA?”, “Am I eligible for one?”, “Is an HSA for me?”, “How do I start this process?”  By the end, you will have a firm understanding of what an HSA is, and whether or not you should ask your Certified Public Accountant (CPA) about one.

Enacted in 2003, HSAs were originally part of the Medicare Prescription Drug, Improvement, and Modernization Act, however, initial contributions were not allowed until 2004.  In the beginning, HSAs earned interest similar to a checking or a savings account.  With the advent of lower commission fees, many providers started allowing participants to invest their HSAs in the market.  Today one is able to open up an HSA, and participate in ETFs, Mutual Funds, and many other investments.  This has encouraged many Americans to use an HSA as a retirement vehicle.  When someone reaches the age of 65, money withdrawn out of an HSA for nonmedical reasons is treated like an Individual Retirement Account (IRA) distribution.

Before we get into the details of HSA eligibility let’s talk about the top reasons why millions of Americans are opening them.  Simply stated, HSAs possesses a triple tax incentive.

First: The money you contribute to an HSA is deductible on your tax return.  For example, if John Smith contributes the maximum amount of $3,550 ($7,100 for family) in 2020 into his HSA, he will receive a dollar for dollar decrease in taxable income of that amount on his 2020 tax return.

Second: Money contributed to an HSA grows tax free inside the account.  For example, if the money contributed to an HSA is invested into an index ETF such as SPY it might earn 8% or 9% a year[2] upon which no taxes would be paid as long as the HSA money is used appropriately, which will be defined later.

Third: Funds are withdrawn tax free as long as it is used for medical reasons.  For example, if John Smith had medical expenses such as an ambulance trip, contacts, eyeglasses, or even bandages[3] he would be able to withdraw the money out of his HSA tax free to pay for these items.  For a complete list of qualified medical expenses for which an HSA can be used, reach out to your CPA, or you can dive into the details yourself by reading IRS Publication 502.

Ok, given that HSAs are AWESOME, the question becomes, How do I start the process?  Now hold on a bit, according to IRS Publication 969[4], four criteria must be satisfied to be eligible to open an HSA:

First: You are covered under a High Deductible Health Plan (“HDHP”).  More on this later, but this is the number one hurdle that most Americans cannot clear.  It is however, likely that your employer has an eligible HDHP available to which you can switch.

Second:  You have no other health coverage except what is permitted under other health coverage.  Wow, you’ve got to love the level of detail the IRS provided with this criteria.  The first time I read this I thought well, what in the world is “other health coverage”?  Stay tuned, as an explanation will be forth coming!

Third: You are not enrolled in Medicare.  Thankfully, this one is self-explanatory, which is extremely rare with IRS publications.  You have to take the easy W when you get one.

Fourth:  You cannot be claimed as a dependent on someone else’s tax return.  So basically, if John Smith is a dependent on his parent’s tax return, he cannot open an HSA.  Wow.  Two fairly easy criteria out of four is not too shabby.  Shout out to the person who wrote IRS Publication 969.

Let’s look closer at criteria number one: “You are covered under an HDHP on the first day of the month”.  This means as of the first day of the month you start depositing money into an HSA, you must be under a health plan that has a MINIMUM annual deductible of at least $1,400 individually or $2,800 for family, in network.  Additionally, the insurance plan must also have an in network MAXIMUM annual deductible and other out of pocket expenses of less than $6,900 individually or $13,800 for family.  The MINIMUM and MAXIMUM annual deductible for in network care should be readily available from your company HR person, or in your health benefits guide.  The great news, is that you are considered an eligible individual for the entire year if you are an eligible individual on the first day of the last month of your tax year which would be December 1 for most taxpayers.

Whew. That got real deep, real fast, but we only have one more criterion to examine.  Number Two: “You have no other health coverage except what is permitted under other health coverage.”  Basically, for most people, the HDHP cannot provide additional benefits for prescription drugs (i.e. a low copay) or doctor’s office visits outside of dental or vision care among a couple of others.  Ultimately, an individual covered under a Preferred-Provider Organization (PPO) health insurance plan normally does not qualify for an HSA.  However, there are exceptions to both.  Due to the technical nature of this criterion, it would be best to ask your CPA or carefully read IRS Publication 969.

Now, at this point when talking about HSAs, people normally say something to the effect of “What is the Catch”?  In other words, if HSAs are so great, why doesn’t everyone have one?  This is a GREAT question, and the decision hinges upon your situation.  Let’s look at some examples by discussing the annual medical expenses of three groups of people:

Group 1: You and your family (if married) never/rarely go to the doctor, and might spend $500 a year in medical expenses.  If you are in this group, call or email your HR person today, and start down the HSA road!  It is a no brainer for you, as you will most likely not only get the benefit of the triple tax incentive as previously discussed, but also your monthly premiums are normally lower under an HDHP/HSA plan as opposed to a Preferred-Provider Organization (PPO) plan, meaning you will be able to save money every month.

Group 2: You and your family (if married) go to the doctor a lot, and have substantial medical bills every year in the amount of $25,000 or greater.   This sounds like a lot, but we are not talking about out of pocket expenses, we are talking actual medical expenses i.e. how much the doctor bills you, even if your insurance covers most of it (These add up pretty fast).  If you are in this group, you need to check your PPO Plan versus the HDHP’s “Out of Pocket Maximum.”  These are normally a pretty similar number, and if your medical bills are high every year, you are probably hitting or getting close to the out of pocket maximums.  In this case, it comes down to whether or not you can afford the difference between the “Out of Pocket Maximum” under your PPO Plan and your HDHP/HSA Plan.  For example, John Smith and his family ring up $25,000 a year in medical bills due to a broken leg of John Jr., medication copays for John and Mrs. Smith like blood pressure medicine, and a hospital bill for baby Rachel.  The Smith’s are probably going to hit the out of pocket maximum, and the Smith’s can swing the $1,500 difference between the PPO and HDHP/HSA Plan’s out of pocket maximum.  They should strongly consider opening up an HSA.

Group 3: You and your family (if married) go to the doctor’s office once every other month, and you have medical bills, nothing crazy, but out of pocket expenses are never above $2,000 (not including monthly premiums) on your PPO Plan.  If this sounds like you or your family, you want to check the “Deductible” amount under the PPO Plan versus the HDHP.  Normally in this instance, the PPO plan will be cheaper, in which case you might not go with the HSA Plan due to the added expense.  However, if you have an emergency fund of 3 to 6 months of expenses saved up, your future self would tell you to bite the bullet, and open an HSA.

Wow, we have covered a lot of ground in the last couple of pages!  You have officially accomplished the feat of drinking from the HSA fire hose.  At this point, you either have had your interest peaked, and are chomping at the bit to talk with HR (yeah right, nobody does that) or, you think this article has been a waste of your time.  If you are in camp number two, no worries.  At least you learned that HSAs were started in 2004 for that random trivia night.  If you are in camp number one, welcome to the HSA bus.  We have one final thing to cover.  How do I start this process?  Glad you asked.  HSAs are one of the few things Uncle Sam encourages regardless of your income level.

There are three easy steps to start down the path and joining the other 22 million Americans who make up this HSA tribe.

First:  Call or email your HR person, and ask them for some paperwork on your health benefits plan.  Most employers have an HDHP/HSA plan, but even if your employer doesn’t, you can still open up one for yourself outside of your work if you are eligible.

Second:  Once you have received the information, you can either visit with your CPA about it, or look over the information yourself.  My suggestion would be to look over the information yourself, and if you are still not sure if you are eligible, visit with your HR person.  If you have no HR person, than most any CPA worth their salt will be able to help you out.

Third:  This is the exciting part!  At this point, you have discovered that you are eligible, or are changing plans at your office to become eligible, and are ready to open an HSA.  Under ideal circumstances, your employer offers an HSA plan and you have access to the automatic paycheck deduction which makes direct deposits into your HSA from each paycheck.  This way you save employment taxes and income taxes.  If your employer does not offer an HSA Plan, but you are still eligible, you can open one up with just about any broker, for example TD Ameritrade, or HSA Bank.  Be sure you can invest in the market so that puppy can grow.

I hope you have learned something about HSAs in the last 9 minutes.  They are one of the hottest ways American’s are securing their own future, by putting money away in tax advantaged accounts, while at the same time saving money for future medical bills.  As icing on the cake, if you are eligible, and over 55, you can contribute an extra $1,000 a year (if you are married, and your wife is eligible, and is over 55, she can open up a separate HSA and place $1,000 in it each year as well).  Looking forward, $3,600 for an individual ($7,200 for family) is the maximum contribution allowed for 2021.