With health insurance costs rising 10-20% each year, more business owners are looking for ways to reduce this cost. Many are implementing high-deductible, HSA-compatible health insurance plans. Here is some information you should know:
Q: What is an HSA, and why should I have one?
A: An HSA is a Health Savings Account. The premiums under HSA-compatible policies are significantly lower than traditional policies, since they have high deductibles. The idea is that one funds the HSA plan, resulting in a Federal tax deduction (sorry-California has not complied with this), and then uses HSA funds to pay any qualified medical costs subject to the deductible. If HSA funds are withdrawn (distributed) for qualified medical costs they are tax-free. (If they are not for qualified medical expenses, they are subject to tax, as well as a 20% penalty.)
Q: How does it work?
A: In order to take advantage of this, you need to
- First implement a high-deductible, HSA-compatible health insurance policy. It’s not enough that it is considered high deductible—it must be HSA compatible. Confirm with your insurance agent that the policy is HSA compatible before you enroll. This needs to occur by December 31 of the current year.
- After you are covered by the insurance policy, you should open a health savings account (HSA) with a financial institution. This is still a relatively new type of account, so not all financial institutions offer it. Although there are many lesser known institutions that specialize in HSAs, a more recognized institution that has experience with HSAs is Wells Fargo Bank. Another OptumHeathBank, is focused on financial solutions for health care and provides investment options with leading mutual funds. For 2011, you can contribute up to $3,050 and $6,150 for single and family policies, respectively, and an additional $1,000 if you are over 55. Contributions must be made by April 15 of the following year.
Q: How do I report this on my tax return?
A: Contributions and distributions are reported on Form 8889, Health Savings Accounts (HSAs). The contribution then flows to Form 1040, line 25, as a reduction in adjusted gross income.
Q: Sounds kind of complicated. Is it really worth it?
A: The significantly lower health insurance premiums alone are a major advantage. If you have chronic or significant health issues, the annual HSA contributions will normally cover most annual deductibles. Further, because the HSA contributions are fully deductible, but medical expenses are only deductible to the extent that they exceed 7.5% of your adjusted gross income (AGI), (increasing to 10% in 2013), if you even itemize deductions to begin with. So you can essentially convert a nondeductible medical expense into a deductible expense. If you are relatively healthy, the advantages are even greater—the contributions can continue to grow in the account (there’s no “use it or lose it”). Further, you can take distributions for non-medical purposes without penalty at age 65, although they would still be subject to ordinary taxation. So, it’s almost like another type of retirement savings vehicle.
If you have additional questions on how an HSA might affect your personal tax situation, please contact us.
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