Individuals divert some of their pretax income to Health Savings Accounts, which are reserved for health costs. They are similar to 401(k) plans, in the sense that money that goes into them is not taxed as income. Distributions are counted as income and taxable from an HSA if the money is used for items other than health care.
HSAs require that a person be enrolled in a high-deductible health plan. High-deductible plans featured average annual family premiums of about $11,000 annually, compared to $13,375 for the average annual family insurance premium in 2009. Under a high-deductible plan, a patient usually must spend a certain amount of money, from $2,300 to $11,600 before insurance begins to pay for medical service. With an HSA, employers can put in a lump sum and employees can divert money from their paycheck to cover this gap. HSAs usually come with a debit card that allows patients to pay for expenses.
Expenses such as doctor visits, ambulance rides, surgery, acupuncture, legal abortion and prescriptions drugs, are tax deductible if they amount to more than 7.5 percent of a taxpayer's adjusted gross income in 2009. But regardless of a patient's adjusted gross income, these expenses are qualifying expenses for the purposes of an HSA. According to the IRS, anything eligible for the tax deduction is a qualifying expense. There is one big difference: over-the-counter medication is not deductible, but it is a qualifying expense. People with HSAs can essentially buy aspirin with their HSA.
Use of HSA funds is restricted to medical expenses. The IRS says you cannot borrow money from the HSA, lease property to an HSA or use any of the money for something other than medical expenses. Doing so means the money you use is taxed as income, and is subject to an additional 10 percent tax penalty. According to IRS guidance, "if you use a distribution from your HSA for qualified medical expenses, you do not pay tax on the distribution but you have to report the distribution on Form 8889."
Keeping good records is important with an HSA. In the event that you have incurred serious medical expenses through the year, you may need receipts for doctor's visits to prove to your insurance company that you have met your deductible. For the IRS, you may need to keep receipts to prove that your expenses through the HSA qualify.
Some supermarkets and drug stores maintain a database of items that qualify for HSA expenses. Upon checkout, the store's computer system will notify you of these products' eligibility and will ask if you want to use an HSA debit card for that portion of the transaction.
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