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How to take advantage of a health savings account deduction

Kate Dore · December 23, 2019 · 6 min read

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After ringing in the New Year, you may be ready for a fresh start with your money. Sticking to a budget, saving more, and paying off debt are all worthy resolutions. You should also prepare for your income tax return. It may be tempting to ignore it until April, but putting it off could increase your chances of mistakes.

By starting earlier in the tax year, you may uncover more opportunities for federal tax deductions. If you qualify, consider opening a health savings account. You may be eligible for a deduction on your federal income tax return, which could mean paying less in taxes to the Internal Revenue Service (IRS). Here's what to know about the health savings account deduction—and how to get ahead for next year's tax season.

How to qualify for a health savings account contributions

If you have a high-deductible health insurance plan, you may have already experienced some costly medical bills. These out-of-pocket expenses can be tough to predict—especially when you receive the bills weeks or months after seeing the doctor. The unpredictability can make a high-deductible health plan difficult to budget for.

One way to soften the financial blow is by opening a health savings account. These accounts offer three ways to save on taxes—but you will have to qualify every year to make annual contributions. Here are some guidelines to keep in mind.

You need an HSA-eligible high-deductible health plan (HDHP).

Not all high-deductible health insurance plans are HSA-eligible. Before making any contributions, you should check with your insurer to make sure your plan qualifies. Otherwise, you may have to answer to the IRS later.

You need to have insurance coverage with an annual deductible of at least $1,350 for an eligible individual or $2,700 for family coverage in 2019. These amounts may adjust every year. As an individual, you won’t pay more than $6,750 for out-of-pocket expenses with in-network providers. The maximum out-of-pocket for a family plan is $13,500.

Your high-deductible health plan may cover some preventative care before you meet the deductible. This may include things like annual physicals, immunizations, and screenings for cancer or heart disease.

You must have a private insurance plan

You won’t qualify for health savings account contributions if you’re currently enrolled in Medicare. You need to have an employer-provided high-deductible health plan—or one of the Marketplace plans through the Affordable Care Act.

You can’t be a dependent on someone else’s tax return.

If you’re considered a dependent on your another person’s tax return, you won’t qualify for health savings account contributions.

If you make contributions, you may qualify for a tax deduction

Once you qualify for health savings account contributions, you may also be eligible for a tax break. There are two ways to get a deduction for putting money into your HSA account.

If your employer makes a contribution, the money goes into your health savings account before income taxes. This means it won't be part of your gross income—and you won't owe federal income tax for your employer’s contribution. You should check to see how your state treats health savings account contributions, though. There may be different state-level tax laws.

You can also deposit money into your health savings account after paying income taxes. The HSA contribution will still impact your taxable income because your deposit is tax-deductible. To claim the tax deduction, you can submit Form 8889 with your tax return.

The maximum 2019 contribution is $3,500 for individuals and $7,000 for families. You may also qualify a $1,000 catch-up contribution if you're 55 or older, too.

If you're self-employed and own a small business, you may also benefit from a health savings account—and the perks that come with it. You should speak with a tax professional to see which type of plan is the best fit for your company's health insurance. Your company may be eligible for tax savings from a health savings account or a medical savings account.

Health savings accounts offer additional tax savings

Tax deductions are one reason for health savings accounts’ popularity. But there are more perks than your tax-deductible HSA contributions. You may also enjoy two additional tax advantages, as well.

The second benefit of your health savings account is tax-free growth. If your health savings account allows you to invest, you won't owe income taxes on your earnings. Your HSA balance rolls over every year, and there is no deadline to use the money. If you contribute and invest every year, you could amass some extra retirement savings.

The third health savings account perk is tax-free withdrawals. You can use the money anytime for qualified expenses. These may include out-of-pocket health care costs like seeing the doctor or dentist. You may also use HSA funds for prescriptions, hospital visits, co-insurance, and co-payments.

Watch for these health savings account rules

Health savings accounts can be a great deal if you follow the IRS guidelines. You may avoid paying income tax or a tax penalty by following these rules.

  • Stick to your annual HSA contribution limit. It may be tempting to deposit extra money for a bigger tax deduction—but this could be a costly mistake. It’s up to you to keep track of your contributions every year. Be careful to stay within the annual limit, or you may owe an excise tax of 6%. You can avoid this penalty by withdrawing the extra contribution money by your tax deadline.

  • Only withdraw money for qualified medical expenses. You can spend HSA money or reimburse yourself for qualified medical expenses anytime. But if you withdraw money for something else, you may have to pay income tax—plus a 20% penalty. Once you turn 65, you won't owe the 20% penalty for non-qualified withdrawals.

Save on taxes with a health savings account

There's nothing like the triple-tax advantage of a health savings account. You may qualify for annual tax deductions, tax-free growth, and tax-free withdrawals—which can be a powerful combination. It's a great way to reduce your taxes while also saving for future health care costs.

Kate Dore

Kate Dore

Kate Dore is a Nashville-based freelance personal finance writer and Candidate for Certified Financial Planner™ Certification. She teaches financial literacy with Junior Achievement and serves as Director of Public Relations for the Financial Planning Association of Middle Tennessee. Her work has been published in Business Insider, Financial Planning Magazine, and Simple Money Magazine.

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Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.

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