How do health savings accounts (HSAs) work?
HSAs are tax-exempt savings accounts used in conjunction with a high-deductible health insurance plan (HDHP) to pay for qualifying medical expenses.
Individuals who participate in a qualifying HDHP can establish an HSA to pay for qualifying medical expenses. Both employees and employers can make contributions to an HSA.
HSAs have many tax advantages. Contributions made by employers are exempt from federal income and payroll taxes, and account owners can deduct any contributions they make from income subject to federal income taxes. Further, any income earned on the funds in an HSA accrues tax-free, and withdrawals for qualifying medical expenses are not taxed. Withdrawals used for nonqualifying expenses are subject to income tax and an additional 20 percent penalty, but the penalty is waived for account holders who are disabled, who are age 65 or over, or who have died. Unused balances can be carried over from year to year without limit.
Annual HSA contributions are limited to $3,400 for an individual and $6,750 for a family in 2017. Account holders age 55 or older can contribute an additional $1,000 to either type of account. The contribution limits are indexed annually for inflation.
In 2014, employers contributed $15.6 billion to HSAs, and individual tax filers contributed another $4.4 billion. The US Department of the Treasury estimates the tax preference for HSAs reduced income and payroll taxes by $7 billion in 2014.
Employers must offer an HSA-qualified insurance plan—usually an HDHP—for an employee to be eligible for an HSA. Individuals may also purchase an HSA-qualified insurance plan through the individual insurance market to become eligible. A plan is HSA-qualified if it meets certain requirements; in 2017, those requirements include a minimum deductible of $1,300 for individual coverage and $2,600 for family coverage.
The Medicare Prescription Drug, Improvement, and Modernization Act authorized HSAs in 2003 to address the rising cost of medical care and the increasing number of uninsured individuals. HSAs are an expanded version of medical savings accounts (MSAs). MSAs also require account holders to have an HDHP and have many of the same tax advantages as HSAs. They are limited, however, to the self-employed or workers in small firms (50 or fewer employees). MSAs were established in 1996, but no new contributions to MSAs could be made after 2007, except for individuals who previously made contributions to an MSA or who work for employers that had already established MSAs.
HSAs and their associated HDHP plans place more of the health care financing burden on out-of-pocket costs and are intended to encourage more cost-conscious spending by health-care consumers. In practice, HSAs accounts are most attractive to higher-income individuals because the value of the tax exemptions associated with HSA contributions, account earnings, and withdrawals are greater for individuals in higher income-tax brackets. Additionally, high-wage workers are more likely to be constrained by contribution limits for retirement account and use HSAs as an additional means of tax-preferred saving.
In 2014, 11.7 percent of taxpayers with income between $100,000 and $200,000 contributed to an HSA, as did 16.4 percent of taxpayers with income over $200,000 (figure 1). In comparison, only 5.1 percent of taxpayers with income between $30,000 and $50,000 made such contributions. The average contribution for taxpayers with income over $200,000 was $4,716, compared with an average contribution of $1,500 for taxpayers with income between $30,000 and $50,000 (figure 2).
HSAs are also attractive to those with low expected health care expenses. Individuals with low expected health care needs enjoy the premium cost-savings of the associated HDHPs, as well as the tax benefits of HSAs, without fear of eventually needing to pay a high deductible.
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Helmchen, Lorens A., David W. Brown, Ithai Z. Lurie, and Anthony T. Lo Sasso. 2015. “Health Savings Accounts: Growth Concentrated among High-Income Households and Large Employers.” Health Affairs 34 (9): 1594–98.
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