Image: Pictures of Money, Flickr.
Continue Reading Below
The most popular tax-favored accounts help people save for retirement. However, there are other tax-favored accounts that serve different purposes. Health savings accounts, also known as HSAs, are designed to offer a way to cut your tax bill while saving to pay for future medical expenses. Below, you'll get essential information on HSAs for 2016 and what you need to know in order to take maximum advantage of them.
What an HSA is and why you might want one
A health savings account is a tax-exempt account you set up with a financial institution to pay or reimburse you for certain medical expenses. Money that you contribute to an HSA is deductible from your taxes, and contributions that your employer makes to your HSA aren't included in your income. Contributions can remain in your account for multiple years until you withdraw them, earning income on a tax-deferred basis. If you use the money for qualified medical expenses, then those distributions are tax-free.
How to qualify for an HSA
In order to qualify for an HSA, you need to be covered under a high deductible health plan or HDHP. No other health coverage is allowed other than certain limited options, including coverage for specific diseases or illnesses or coverage for dental, vision, or long-term care. In particular, those who participate in Medicare are not allowed to have an HSA. Finally, those who are treated as dependents on someone else's tax return can't qualify for an HSA.
As its name suggests, the HDHP requirement limits HSA usage to policies that have relatively high annual deductibles. For 2016, the minimum deductible for individual insurance policies is $1,300, and for family policies, the minimum is $2,600. In addition, the maximum out-of-pocket amount for an individual policy is $6,550, while the family limit is $13,100.
Limits on contributions
The maximum you can contribute to an HSA depends on the type of policy you have. In 2016, if you have a policy that only covers yourself, then your maximum contribution is $3,350. For those who have family coverage under a high deductible health plan, the maximum contribution for 2016 is $6,750.
Continue Reading Below
Those who are age 55 or older get to make an additional contribution to an HSA. To calculate the amount, add $1,000 to the standard maximum contribution.
What happens when you enroll in Medicare?
Once you enroll in Medicare, your contribution limit immediately becomes zero. However, you're allowed a pro-rated contribution for the year in which you become eligible. For instance, if you turn 65 and enroll in Medicare in July, then you can make an HSA contribution of up to one-half the annual amount, because you were not enrolled in Medicare for six months or one-half of the year.
When HSA contributions are due
In order to make an HSA contribution for a given tax year, you have to get the money into the account by the filing deadline. For the 2015 tax year, that means you have until April 18 to fund your HSA. Employers are also eligible to make contributions through April 18 that can count toward the 2015 tax year.
Distributions for qualified medical expenses
You can take money tax-free out of your HSA to pay for prescription drugs or for expenses that qualify for the medical expense deduction. This generally includes inpatient and outpatient medical services. The expenses can be incurred by you, your spouse, or any dependent for tax purposes.
What happens to an HSA after your death
HSAs require the account holder to name a beneficiary. The person you select inherits the HSA after your death. If your beneficiary is your spouse, then the HSA gets treated as your spouse's HSA. All other beneficiaries must include the full value of the HSA as taxable income in the year in which you die.
Health savings accounts offer valuable tax savings. Not everyone can qualify, but it's worth taking a look to see if you can put the power of HSAs toward cutting your tax bill.
The article What You Need to Know About HSA Taxes in 2016 originally appeared on Fool.com.
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright 1995 - 2016 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.