Imagine getting in a car accident and needing emergency surgery. Your insurance plan covers some of the cost, but you have to put the rest of it on a credit card, and it will take years to pay off the balance. Learn How an HSA affects your Taxes
If you want to avoid such a situation, you should consider an HSA (health savings account). The account can help you prepare for the unexpected so that you can handle almost anything that comes your way.
Read on to learn about the tax implications of an HSA and How an Health Savings Account Affects Your Taxes.
How a Health Savings Account Works
A health savings account is a type of account you can use to save money for medical care. You need to enroll in a high deductible health plan (HDHP) to qualify.
When you have an eligible health plan, you’ll be able to set up an HSA. Then, you can contribute money throughout the year to help pay for visits to the doctor, prescriptions, and similar costs.
If you ever need to pay for medications or an appointment with a doctor, you can use a debit card. This card connects to your HSA, so you don’t need to pay money from your regular bank account.
Unfortunately, you can’t contribute as much money as you want to your HSA. If you have an individual health savings account, you’ll be able to contribute up to $3,650 in 2022.
People with family HSAs can save up to $7,300 this year. When you turn 50, you’ll be able to save an extra $1,000 per year to help cover your medical expenses.
The contribution limits for individual and family HSAs usually go up each year. So keep an eye on those limits so that you can maximize your savings with this tax-deductible account.
Setting Up an HSA
The way you set up an HSA depends on if you’re an employee or self-employed. When you receive health insurance through your employer, the company will set up your HSA when you enroll in an HDHP.
Your employer can set up payroll deductions so that you can easily make pretax contributions. Then, all you have to worry about is choosing the right amount of money to save with each paycheck.
If you work for yourself and have your own health insurance, you’ll need to set up an HSA yourself. An easy option is to go through your bank or credit union.
You can also look at other HSA providers. Some may offer certain advantages, such as the option to set up recurring contributions, so you don’t have to manually move your money each month.
As a freelancer, you don’t have an employer making your contributions before taxes. However, you’ll be able to take your HSA contributions as a tax deduction at the end of the year.
Your HSA and Taxes
Understanding the basics of how an HSA works is great. But a lot more goes into your HSA and how it affects your taxes.
Whether you work for yourself or have an employer, you should know what an HSA might do to your tax return. Then, you can consider the advantages and disadvantages of using such an account.
Here are some things you should think about before setting up your HSA.
Lower Your Taxable Income
One of the best ways having an HSA can affect your taxes is by lowering your taxable income. Consider if your gross earnings are $50,000, and you contribute the maximum for an individual of $3,650.
Your taxable income would decrease to $46,350. While that may not sound like much, it could help lower your tax burden, especially if you have other tax deductions.
All of the money you contribute to your HSA will be tax-free. Whether you earn a lot of money or not, maxing out your HSA each year can lower your earnings, and it may even put you in a lower tax bracket.
Another one of the tax advantages of an HSA is that you can earn interest tax-free. Usually, when you earn interest on a traditional savings account, you have to pay taxes on those earnings.
However, your money can grow without incurring any taxes. If you contribute to an HSA and don’t use it for a while, the balance can grow, and you may be able to cover a big emergency.
You can also set up your HSA to automatically invest your money after your account hits a certain balance. This can be an easy way to earn even more money and not have to pay taxes on it.
Even if you’re healthy now and don’t think you’ll need the money, you never know what might happen. It’s good to save now in case you get sick or need more medical care.
Not only do you make pre-tax contributions, but you can also withdraw money without paying taxes on it. However, you can only do this if you use the money to cover eligible expenses.
If you take out the money for groceries or a night out, you’ll have to pay taxes on that amount. Still, if you often have medical expenses, an HSA can be an excellent way to pay for those.
Unlike other tax-advantaged savings accounts, such as 401(k)s, you don’t have to pay taxes when you take out money. That can come in handy if you ever need expensive surgery.
Understand Eligible Expenses
Before you use your HSA, you should consider what will qualify for tax-free withdrawals. Many common medical expenses will qualify for tax-free spending, so you can use your HSA card for routine things.
For example, you can use your card to pay for prescriptions and regular doctor visits. The CARES Act also updated guidelines to allow HSAs to cover certain over-the-counter medications as well.
Unfortunately, you can’t use your HSA money to pay for your health insurance premium. Other ineligible expenses include gym memberships, teeth whitening, and elective surgery.
Keep Your Receipts
One of the potential disadvantages of an HSA comes up if you have trouble organizing paperwork. You’ll want to keep a copy of all relevant receipts to prove you’re using your health savings account for eligible costs.
That will help you show the (Internal Revenue Service) IRS that you aren’t trying to get out of paying taxes that you owe. Be sure to set up a folder in your home or on your computer where you can scan and store receipts for tax season.
You should also keep receipts for any medical expenses you pay for using your regular debit or credit card. If you ever need to access your HSA money, you can withdraw the amount you’ve spent on medical costs using other means.
As long as you can prove you’ve spent that much on medical care, you can get the money tax-free.
Look for Tax Forms
If you use your HSA for anything, you’ll need to look out for Form 1099-SA from your HSA provider. They should mail you a copy of the form so that you can include it with your tax return.
This form tells the IRS how much money you spent using your HSA for the prior year. It will also tell you how much you spent on non-qualifying expenses.
That way, you’ll be able to prepare for the 20 percent tax that amount will incur. You can also compare the form to your receipts from the prior year to make sure you don’t miss anything in your records.
No Requirement to Spend
It may seem like an HSA is the best for people with chronic health problems. However, healthy people can benefit significantly from having and contributing to a health savings account.
Compared to the similar flexible spending account (FSA), both cover medical costs. With an FSA, though, you’ll lose the money you contribute after each year.
If you set up an HSA, that money can roll over forever. That means you may be able to save thousands of dollars to prepare for a medical emergency or even routine care, such as giving birth.
Once you turn 65, you can withdraw the balance for any expense, medical or not. At that age, you won’t have to pay taxes on anything you use the HSA money for.
Maintain an HDHP
One of the drawbacks to having an HSA is that to contribute to it, you need to enroll in an HDHP. However, you have to continue to enroll in that type of account each year.
If you switch back to a traditional health insurance account, you won’t be able to make more pre-tax contributions. You will be able to withdraw the money for qualifying expenses, though.
Keep that in mind each year when shopping around for health insurance plans. Fortunately, HDHPs tend to come with lower premiums, so you can save money on your health overall.
Will You Use an HSA?
Having an HSA can be an excellent way to save money on your health expenses. What you may not know is that it can also help you save on your taxes.
But you have to be careful so that you can maintain eligibility and only use your HSA for qualifying costs. Then, you can enjoy the tax benefits of this amazing account.
Do you want to determine if an HSA is worth it? Use an income tax calculator to see how much you could save with an HSA.
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