Health Savings Accounts: Save for Medical Costs and Reduce Your AGI

HSA-Qualified High-Deductible Plans are Steadily Gaining in Popularity

HSAs can be a useful tool, both for lowering income and for saving money
An HSA might be just what you need to lower your AGI enough to get a subsidy AND save to pay for medical costs. Peter Dazeley/Photographer's Choice/Getty Images

Health Savings Accounts (HSAs) were created as part of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003. They first became available for consumers in 2004, and were designed to replace the medical savings account (MSA). In 2006, there were 3.2 million Americans enrolled in HSA-qualified health plans. By 2015, that had grown to 19.7 million.

Who can open an HSA?

As long as you're covered by an HSA-qualified High Deductible Health Plan (HDHP), you can establish an HSA and contribute pre-tax funds to the account.

Note that not all plans with high deductibles are HDHPs. In order to be an HDHP, the health plan must cover only preventive care before the deductible is met; all over claims are counted towards the deductible. In addition to minimum deductible requirements, HDHPs also have maximum out-of-pocket limits that are lower than the overall maximum out-of-pocket limit allowed under the ACA in 2016. In short, don't assume your plan makes you eligible to open an HSA unless it's specifically described as an HSA-qualified plan.

HSA contribution = lower MAGI

With that said, if you do enroll in an HDHP, opening an HSA and contributing to it throughout the year is a very wise move. This is true for anyone who wants to build a savings cushion to cover future medical bills, but it's especially true for people who buy their own health insurance through an ACA exchange. HSA contributions (along with traditional IRA contributions) are "above the line" deductions on the 1040, which means you get to deduct them on your tax return without itemizing your deductions, and they result in a lower adjusted gross income (AGI).

And they don't have to be added back in when your modified AGI is calculated to determine your premium subsidy eligibility.

Let's say you're a family of four, earning $100,000/year, with two 40-year-old parents, and two kids. You don't qualify for any premium subsidy at all, because your income is more than 400% of the poverty level.

And according to Kaiser Family Foundation's calculator, the national average cost for a silver plan for your family is $895/month (actual premiums vary considerably from one area to another - you can enter your zip code to get a more exact number for your own scenario).

Now let's say you enroll in an HDHP and set up an HSA to go with it. If you contribute the maximum allowed in 2015 ($6,750 if you have family coverage under the HDHP), your AGI drops to $93,250, which means you'd qualify for a subsidy of $144/month (this is a national average - subsidy amounts also vary considerably from one area to another). That means your health insurance policy will be even more affordable (to the tune of $1,731 in premium savings, thanks to the subsidy), and at the same time, you're saving money to cover future medical expenses.

For 2017, the maximum allowable HSA contribution will be unchanged for families, at $6,750. But individuals will be able to contribute up to $3,400, which is a $50 increase over the 2016 contribution cap.

How does an HSA work?

HSA funds can be used to cover the out-of-pocket costs on your HDHP, and they can also be used to pay for qualified medical expenses that aren't covered by your health plan. As long as you use the money for qualified medical expenses, you can withdraw it at any time in your life, with no taxes or penalties.

If you take money out of the HSA before age 65 for purposes other than qualified medical expenses, you'll have to pay taxes and a penalty. But once you're 65, you can take money out of the HSA for any reason you like, paying only income taxes (but no penalty) if the money isn't used for qualified medical expenses. At that point, the HSA functions much like a traditional IRA, although you can also just leave the money in the account to cover eventual long-term care expenses that you may face towards the end of your life.

In short, an HSA allows you to set aside funds to pay future medical bills, and the contributions lower your AGI. For people whose income is a little above 400% of the poverty level, HSA contributions might be sufficient to make them eligible for premium subsidies - this is particularly important for people who are facing a subsidy cliff.

HDHPs and HSAs aren't for everyone

HDHPs admittedly aren't the best choice for all enrollees. If you expect to incur significant medical bills in the coming year, a traditional health plan with copays and a lower out-of-pocket maximum might make more sense, even if it comes with higher premiums and no access to an HSA. But if you're healthy and have the means to fund an HSA, an HDHP combined with an HSA might be just what the doctor ordered.

Opening and funding an HSA

The HSA contribution limit for 2016 is $3,350 if your HDHP covers only yourself. If you have family coverage under your HDHP, you can contribute up to $6,750 to your HSA. Once you've got an HDHP in place, you can establish an HSA with any HSA administrator you choose. There are numerous options available; two of the most competitive are UMB Bank and HSA Bank - enrollment and contributions can be done online in both cases. They both offer a good selection of low-priced HSAs that run the gamut from basic savings to fully-invested funds. HSA Bank has more investment options, but higher average fees. UMB Bank has minimal fees, but fewer investment options - although they do offer funds from Vanguard, which is a popular choice among investors. 

As long as you remain covered by the HDHP, you can continue to contribute to the HSA. If you switch to a different health plan that's not an HDHP, you'll no longer be able to contribute to the HSA. But the funds you've accrued will still be yours, and will continue to grow as long as you leave them in the HSA. If you obtain coverage under an HDHP again in the future, you'll be able to resume contributions to your HSA.

Sources:

Congress.gov, H.R. 1 Medicare Prescription Drug, Improvement, and Modernization Act of 2003. Accessed May 10, 2016

Internal Revenue Service, Publication 502 - Medical and Dental Expenses for use in preparing 2015 tax returns, Accessed May 10, 2016

Internal Revenue Service, Revenue Procedure 2016-28. Accessed May 16, 2016.

UC Berkeley Labor Center, Modified Adjusted Gross Income Under the Affordable Care Act, June 2014, Accessed May 10, 2016

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