Tax-Wise Way to Pay Medical Costs

Health Savings Accounts or HSAs which taxpayers can use to help control escalating medical costs have been around for several years now.

What is an HSA? Essentially, it works like this: Individuals and businesses buy less expensive health insurance policies with high deductibles. To qualify in 2021, participants must be enrolled in plans which require them to pay at least the first $1,400 of medical expenses, $2,800 for a family, before the insurance begins to pick up the tab (unchanged from 2020). The high deductible insurance is combined with an HSA.

Contributions to the accounts are made on a pre-tax basis. The money can accumulate year after year tax free, and be withdrawn tax-free to pay for a variety of medical expenses such as doctor's visits, prescriptions, chiropractic care and premiums for long-term-care insurance.

Participating employers can also contribute to accounts, on behalf of employees. HSAs enable self-employed people and businesses that currently do not have health insurance to utilize high-deductible plans with more affordable premiums.

HSAs are similar to Archer Medical Savings Accounts, but they have several advantages. With an HSA, both employee and employer contributions are permitted in the same year. Annual contributions are allowed up to 100% of the annual deductible, which in 2021 (and 2020)  must be at least $1,400 for self-only and $2,800 for family coverage and unused funds can be carried over from one year to the next. The Archer Medical Savings Account pilot program has been hampered by numerous restrictions and has not been widely used up to this point. Taxpayers with Archer accounts can now roll over their balances tax-free into an HSA.

These accounts also have some features of flexible spending accounts (FSAs), with one big difference: They do not have a "use it or lose it" feature. Unlike FSAs, you can carry over any unused funds to the next year.

If you withdraw money from an account and don't use it to pay qualified medical costs, the withdrawal is taxable income and generally subject to a 10% penalty tax.

Another advantage: HSAs are portable — meaning if employees change jobs, they can take the accounts with them.

The National Small Business Association gives the following example of how the new accounts could help employers save money: A small business with 15 employees now pays $72,000 in health insurance premiums a year for a policy with a low deductible. By switching to HSAs, it cuts its premiums to $40,000 a year by changing to a plan with a $2,600 deductible. The business then contributes $1,000 to each of its 15 employees HSAs.

Employees contribute $1,500 each. The company's total insurance cost is $55,000 with HSAs, compared with $72,000 with a low deductible policy. Employees get to keep any unused money in their accounts.

For more information about HSAs, consult with your tax advisor.

Health Savings Account Basics

Married couples filing jointly can set aside up to $7,100 in 2020 (up from $7,100 in 2020), tax free, to save for medical expenses. For self-only plans the maximum contribution is $3,600 in 2021 (up from $3,550 in 2020).

Depending on your tax bracket, in 2021 you can save between 10% to 37% on any costs covered by money in your account.

Every year, the money not spent can stay in the account and gain interest tax-free, just like an IRA.

The accounts are beneficial for small business owners and their employees. Reason: More businesses can now cover workers for major medical problems, such as hospitalization for an injury or illness. Employees can use the accounts to cover doctors visits, lab tests and other costs.

Employers can contribute to employee accounts.

Neither employers nor employees pay taxes on money contributed to HSAs.

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