Understanding HSA: Health Savings Accounts and What They Can Offer

A health savings account (HSA) combines a high deductible health plan (HDHP) with a tax-favored savings account. The funds contributed to an HSA result in Federal and state income tax savings in the year of contribution. There are several advantages to owning and using an HSA, as summarized here:

• Tax-deductible contributions. Contributions made to the HSA are 100 percent tax-deductible, up to the legal limit. This is similar to contributions made to a deductible traditional individual retirement arrangement (IRA). Also like a deductible traditional IRA contribution, a contribution to an HSA is reported on one’s income tax return as an adjustment to income (an “above-the-line” deduction). In other words, an individual does not have to itemize on his or her income tax return in order to get a tax benefit by contributing to his or her HSA. But unlike a deductible traditional IRA that some Federal employees own and contribute to, there are no adjusted gross income (AGI) limitations for contributing to an HSA. Because permanent Federal employees are covered by at least one pension plan – namely, a CSRS or FERS retirement – IRS rules restrict how much (if any) Federal employees can contribute to a deductible traditional IRA.
• Tax-free distributions. Withdrawals from an HSA to pay for qualified medical, dental, vision or long-term care expenses are not taxed. This is unlike a deductible traditional IRA in which withdrawals are fully subject to Federal and state income taxes.
• Tax-deferred earnings. HSAs accrue earnings which accumulate tax-deferred. The accrued earnings are tax-free when withdrawn to pay for qualified medical, dental, vision or long-term care expenses.
• HSAs remain the property of the owner. Unlike a health care flexible spending account (HCFSA), unused money in an HSA is never forfeited. Withdrawals can be made tax-free to pay for qualified medical expenses, even when the owner is not covered by an HDHP. For example, the HSA owner uses HSA funds to pay for qualified expenses in retirement.

In order to contribute to an HSA, an individual must enroll in a High Deductible Health Insurance Plan or HDHP. An HDHP also features higher out-of-pocket maximum limits compared to other types of health insurance plans. With an HDHP, the annual deductibles must be met before insurance plan benefits are paid for medical services other than in-network preventive care services which have 100 percent coverage before the deductible is met.

The Federal Employee Health Benefits (FEHB) program offers HDHPs to employees. The following employees are eligible to participate in an HSA – that is, contribute to an HSA – through their enrollment in a FEHB-sponsored HDHP: (1) Employees not enrolled in any part of Medicare – Medicare Part A, Part B, Part C or Part D; (2) employees not enrolled in additional health insurance plan associated with a non-HDHP health insurance plan, either themselves or through a spouse; and (3) employees not claimed as a dependent on someone else’s federal income tax return.

Note that being enrolled in a Federal or private dental, vision or long-term care insurance plan will not disqualify an individual from participation in an HSA. But participation in one’s health care flexible spending account (HCFSA) or through a spouse’s HCFSA will disqualify an individual from contributing to an HSA.

The following is a list of FEHB program insurance plans offering HDHPs during 2019 for Federal employees:

List of Nationwide High Deductible Health Plans During 2019

APWU Health Plan

Blue Cross and Blue Shield Service Benefit Plan

Compass Rose Health Plan

Foreign Service Benefit Plan

GEHA

MHBP – Consumer Option

NALC

Panama Canal Area Benefit Plan

Rural Carrier Benefit Plan

SAMBA

An HSA is administered by a trustee or custodian, similar to an IRA. If the HSA owner dies, then a spousal beneficiary will inherit the HSA and use it as his or her own, making qualified withdrawals to pay for out-of-pocket medical, dental and vision expenses. Non-spousal beneficiaries of an HSA such as children must withdraw funds from the HSA and pay Federal and state taxes on withdrawals but no early withdrawal penalty.

Each year, the IRS announces limits on contributions to HSAs, HDHP minimum deductibles, and maximum out-of-pocket spending amounts under HDHPs linked to HSAs. The following table summarizes the IRS limits for 2019:

Penalties for Using HSA Withdrawals to Pay Nonqualified Expenses

Those HSA owners under the age of 65 (unless totally and permanently disabled) who make HSA withdrawals to pay nonqualified medical expenses face a 20 percent penalty of the HSA funds used for such expenses. Funds spent for nonqualified purposes are also subject to Federal and state income taxes.

Dependent Children

While the FEHB program allows employees to add their adult children (up to age 26) to their FEHB health plans, the IRS definition of a qualified dependent (as to which family member may be covered under an employee’s HSA) is different. This means, for example, a Federal employee whose 25-year-old child is covered under his or her HSA-qualified FEHB HDHP plan may not be eligible to use HSA funds to pay for that child’s out-of-pocket medical, dental or vision expenses. The exception would be if the child is a full-time student and therefore a qualified dependent for Federal income tax purposes.

In short, these are the steps for a Federal employee to participate in an HSA in the FEHB program:

1. The employee enrolls in an HDHP under the FEHP program.
2. The employee’s HDHP establishes an HSA with a fiduciary (each HDHP has more information on how this step works in the HDHP Plan Brochure).
3. The HDHP automatically contributes a portion of the employee’s FEHB premium into the employee’s HSA (the “premium pass-through”). A sample of the 2018 “premium pass-through” amounts may be viewed here.
4. The employee can make additional contributions to their HSA up to the IRS’ annual maximum contribution limit, as shown above in the table under “HSA contribution limit (employer and employee)”
5. The HDHP will provide the employee or a member of the employee’s family preventive care without cost to the employee, subject to any limits outlined in the HDHP’s Plan Brochure.
6. The employee will pay the full cost of non-preventive care for the employee or for a member of the employee’s with funds from the HSA or out-of-pocket, up to the plan’s high deductible amount.
7. If an employee incurs out-of-pocket medical expenses that reach the HDHP’s maximum out-of-pocket limit, the employee’s HDHP will then cover needed care with no charge to the employee. This assumes the employee uses in-network providers.

Other key features of HSAs that employees should be aware of:

1. Distributions from one’s HSA are tax-free to pay for the qualified medical expenses (as explained in IRS Publication 502 – Medical and Dental Expenses, and downloadable here) for the employee, the employee’s spouse, and the employee’s tax dependents. This is true even if the spouse or tax dependents are not covered by an HDHP.  
2. HSA may allow the contributions to the HSA to grow tax-free over time, similar to a Roth IRA. This is true even if the HSA leaves or retires from Federal service.
3. HSA owners are highly encouraged to shop around for an HSA custodian who will be most aggressive in investing the funds in the HSA, especially if the HSA owner is relatively young. Using very simplified assumptions, it is possible to calculate for today’s employees the future benefit of an HSA during the accumulation phase of an HSA. For example, assuming a return of 6 percent and if a 25-year-old HSA owner rolls over half of the annual HSA contribution of $3,400 ($1,700) from year to year (that is, funds are not withdrawn and spent on health care), his or her HSA could grow to $288,000 by the time he or she is age 65 and retired. At that time, the HSA owner could make HSA withdrawals income tax-free to pay for out-of-pocket medical (including Medicare Part B premiums), dental, vision, and long-term care (including long-term care premiums) expenses. If they are age 65 or older, they can make HSA withdrawals to pay for nonmedical expenses but they must pay regular income tax with no penalty. In that way, the HSA is no different than a traditional IRA.

HDHPs with HSAs give employees greater control over how their healthcare dollars are spent, both out-of-pocket monies and with funds from their HSAs. As with most FEHB fee-for-service plans, HDHPs provide the most cost-effective coverage when enrollees use network providers.

Written by Edward Zurndorfer, who is a Certified Financial Planner™, Chartered Financial Consultant, Chartered Life Underwriter, Certified Employee Benefits Specialist and Enrolled Agent in Silver Spring, MD. He is the owner of EZ Accounting and Financial Services, an accounting, tax preparation, and financial planning firm also located in Silver Spring, MD. He is a seminar speaker at Federal employee retirement seminars throughout the country for the National Institute of Transition Planning, Inc. He is also a weekly columnist for MyFederalRetirement.com. Raymond James is not affiliated with and does not endorse the opinions or services of FEDZONE or Edward A. Zurndorfer or any of the above-listed organizations. The information has been obtained from sources considered reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Edward A. Zurndorfer, and not necessarily those of RJFS or Raymond James. Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize, or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website’s users and/or members. Raymond James does not offer tax or legal services. You should discuss tax or legal matters with the appropriate professional. Securities offered through Raymond James Financial Services, Inc., Member FINRA/SIPC. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Serving Those Who Serve is not a registered broker/dealer and is independent of Raymond James Financial Services