First Person: What Employees Need to Know About Health Savings Accounts

Health Savings Accounts (or HSAs) have become popular options in the past few years for those seeking more control over their medical expenses. HSAs are tax-deferred savings accounts that can be used for medical expenses on a tax-free basis or to defer taxes for retirement planning. The rules for HSAs can be confusing and I often have tax clients call with questions about how they work. Here are the top five questions and answers about Health Savings Accounts:

How do I know if I'm eligible to register a Health Savings Account?

HSAs are available only to those who are enrolled in High-Deductible Health Plans (HDHPs) through their employers. Your HDHP plan will inform you whether it is eligible or not. You can set up an HSA through your employer or through a bank or other financial institution.

What happens to deposits that my employer makes if I'm laid off or change jobs?

This is where an HSA has a substantial benefit over a 401(k) retirement savings plan. If you have a 401(k) that an employer contributes to you often don't own those funds right away. There is often a vesting period during which those funds revert to the employer if you leave. However, all contributions to an HSA, regardless of who makes them, are yours right away. Your entire fund travels with you from employer to employer. If you do not enroll in an HDHP at your new place of employment, you will not be able to make new deposits into your HSA, but you will still be able to access the funds already there.

What kind of medical expenses can I use the funds for?

You can use your HSA funds for qualified medical expenses without paying tax on the withdrawal. Qualified medical expenses include most doctors' office charges including co-pays as well as chiropractic, dental, and optometry. Until January 1, 2011, you can also use your HSA funds for non-prescription drugs, such as aspirin. After January 1, you can only use it for medications that come through a prescription.

Can I take money out of my HSA for emergency expenses?

You can withdraw the funds in your HSA for any reason. However, for any withdrawals other than for qualified medical expenses, you will pay income tax on the withdrawal plus a 10% penalty. On January 1, 2011, that penalty increases to 20%. The penalty is waived for those over 65 and those who are disabled at the time of the withdrawal, however the income tax still applies.

What happens to my HSA funds when I die?

Like an IRA, any funds left in your HSA when you die will transfer to your stated beneficiary. If the beneficiary is a surviving spouse, the rollover will happen on a tax-deferred basis. The funds won't be taxed until the spouse withdraws them.

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