What is an HSA and What are the Tax Benefits?

First of all, I hate typing HSA because it is always auto-corrected to HAS.  HSA stands for Health Savings Account.  Please don’t confuse it with the alphabet soup of other related terms, MSA (Medical Savings Account), FSA (Flexible Spending Account), HRA (Health Reimbursement Arrangements).

Health Savings Accounts are a great tool for small business owners to save taxes and build savings.  First, the requirements to set one up.  Any bank or financial entity CAN hold the funds, but only a select few do.  

To make tax-deductible contributions to an HSA,  you must have a High Deductible Health Plan.  Health Savings Accounts were created prior to Obamacare, so many policies now qualify as High Deductible.  For an individual, the minimum deductible for an individual must be $1,400, and the maximum deductible no more than $6,900.  For families, the minimum must be $6,900 and the maximum is $13,800.  Only “in-network” services are used to calculate these amounts.

Now that you have your insurance and your HSA, you’re ready to make contributions!  For 2021, the limit is $3,600 for individuals and $7,200 for families.  If you are over 55, you can contribute an additional $1,000 per year. Contributions are tax-deductible, the earnings in the account are not taxable, and the distributions, if made for qualified medical expenses, are not taxable.  Win-win!

Qualified medical expenses are those generally considered to qualify for the medical and dental expenses deduction on your income tax return.  These include over-the-counter medicine and menstrual care products.  Expenses can be for you and your dependents claimed on your return.  Long-term care, COBRA, and Medicare (if you are over 65) premiums are also qualified expenses, but not your normal medical insurance premiums.

Bonus round.  You don’t have to take distributions.  Many people confuse Health Savings Accounts with Flexible Savings Accounts which require you to spend the money in the year you contribute it, or you lose the balance.  Not so with a Health Savings Account.  One strategy is to invest in longer-term investments in your HSA, let it accumulate, and use it in retirement when you have more medical expenses.

One last benefit for small business owners.  Employers can make contributions to HSAs for their employees.  Recently, we were surprised by a reduction in our insurance premiums.  We used part of this savings to contribute to every employee’s HSA.  Nice tax (and payroll tax) free benefit for them, and tax deduction for Core.