If you qualify, making a contribution to a Health Savings Account (HSA) can help you lower your taxes. You could save anywhere from $300 to $2,000 on your federal income taxes! You could save even more if your employer allows you to make pre-tax contributions because you won’t pay FICA taxes (Social Security and Medicare). Here’s what you need to know:
What is an HSA?
An HSA is a tax-exempt account designed to pay or reimburse you for certain medical expenses. If you qualify, contributions are deductible up to a specific limit. Also, you do not pay taxes on the earnings in your HSA. Distributions for medical expenses are also tax-free.
Do You Qualify?
To be eligible for an HSA, you must meet these requirements:
- You must be covered under a high deductible health plan (HDHP) by the first day of the last month of your tax year (usually December 1).
- You must have no other health care coverage. (Excluding worker’s compensation, coverage for a specific disease or illness, coverage for a fixed amount per day of hospitalization, accidents, disability, dental, vision, or long-term care)
- You must not be enrolled in Medicare.
- You cannot be claimed as a dependent on someone else’s tax return. (This applies even if the other person chooses not to claim you.)
The definition of a high deductible health plan (HDHP) depends on whether the coverage is just for you (self-only) or for your family. The definition also changes every year because the limits are increased for inflation. For self-only (single) coverage in 2009, an HDHP must have a minimum deductible of $1,150 and maximum out-of-pocket expenses of $5,800. Those amounts go up to $1,200 and $5,950 in 2010. For family coverage in 2009, an HDHP must have a minimum deductible of $2,300 and maximum out-of-pocket expenses of $11,600. Those amounts increase to $2,400 and $11,900 in 2010.
Your employer or insurance company should be able to tell you if your health insurance qualifies as an HDHP. Check with them if you’re confused.
How Much Can You Contribute?
The next thing you need to figure out is how much you can contribute without incurring any penalties. If you’re single, the contribution limit is $3,000 ($3,050 in 2010). If you have family coverage, the contribution limit is $5,950 ($6,150 in 2010). If you are over age 55, you can contribute an additional $1,000 (does not increase in 2010). If you’re married, you’re both over age 55, and your spouse has his/her own HSA, then you can each contribute an additional $1,000 (to your separate HSAs). (If only one of you has an HSA, you can’t contribute an extra $2,000 even if both of you are over 55. You can only contribute an extra $1,000.) So you’ll be able to contribute anywhere from $3,000 to $7,950 in 2009.
When to Contribute
You can make contributions to your HSA until April 15 of the following tax year (just like Traditional and Roth IRAs). So if you want to make a contribution for 2009, you have until April 15, 2010 to do so.
What Can You Use Your HSA For?
Technically, you can withdraw money from your HSA for anything. But you’ll have to pay taxes plus a 10% penalty on withdrawals for anything other than qualified medical expenses. You don’t pay taxes on qualified medical expenses. To determine what is and is not a qualified medical expense, you’ll want to check out IRS Publication 502. In addition to the medical expenses outlined in Pub 502, you can also include non-prescription medicines, premiums for long-term care insurance, premiums for health insurance under COBRA or while you receive unemployment compensation, and premiums for Medicare if you’re over 65 (excluding supplemental and Medigap policies).
Even if you won’t have any qualified medical expenses this year, an HSA could be a valuable tool during retirement. Think of it as an IRA for medical expenses. If you’re young, setting aside $1,000/year or so in an HSA for your medical expenses in retirement could be a great way to reduce your taxes now and get tax-free withdrawals in retirement. If you’re nearing retirement, maxing out your HSA would be a great way to accomplish the same thing.
Don’t Forget to Claim the Deduction!
You’ll need to make sure you claim your deduction for HSA contributions on your federal income tax return. You’ll take the deduction on line 25 on Form 1040, and you’ll need to attach Form 8889 as well. (Or you can just tell your tax preparer.) But unless you’re able to contribute to an HSA using pre-tax contributions through your employer, you won’t get any benefit at all if you don’t claim the deduction!
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