Health Savings Accounts (HSAs) provide a tax-free way to save for medical expenses. What makes an HSA different from other arrangements, such as health reimbursement accounts, is that the money belongs to you---and it stays with you, even if you leave your job.
The U.S. Department of the Treasury issues regulations governing HSAs. Those regulations offer various tax advantages---for instance, interest accrues tax-free---but they also come with restrictions.
Pre-tax Contributions
Employer contributions are not considered taxable income; they are pre-tax contributions. Moreover, contributions you make to your HSA are deductible from federal income taxes, even if you don't itemize---something called an "above the line" deduction. This allows you to reduce your taxable income by the amount contributed to the HSA.
IRA Rollover
You can make a one-time transfer from an IRA to an HSA. The amount of the IRA transfer counts towards your HSA contribution for that year. (The IRS limits how much you can contribute in a given year, and the figure is adjusted annually. The 2010 cap is $3,050 for an individual and $6,150 for family coverage.)
Tax-free Withdrawals
HSA funds used for qualified medical expenses are tax-free. In other words, you pay no taxes on the money you deposit in your HSA, and you pay no taxes on the money you withdraw to pay medical bills.
Additional Contributions
Individuals aged 55 and older can deposit an additional $1,000 each year until they enroll in Medicare.
Limitations
HSA funds can be used only for qualified medical expenses, which are spelled out in IRS Publication 502 (see Resources below). If you withdraw money for something other than qualified health expenses, those funds are taxable and you may face financial penalties.
You must also be enrolled in a health plan with a high deductible to qualify for an HSA.
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