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Increasing Penalties for Health Savings Accounts

We continue our in-depth look at the health care bill [1] and how it might impact your finances. This afternoon, we’ll cover HSAs and HDHPs.

I often trumpet the combination of a High Deductible Health Plan (HDHP) [2] and Health Savings Account (HSA) [3] as an effective way to save money on health insurance and receive a tax break on out-of-pocket expenses. The new health care bill won’t do anything to change HDHPs – in fact, they are being used as a model for the new state-sponsored health care exchanges. However, there will be a few key changes to HSAs [4].

HSA Changes

  • OTC Medicines: Beginning in 2011, HSA funds cannot be used for over-the-counter medicines unless specifically prescribed by a doctor. This is similar to the new restrictions on FSAs [5], which will prevent funds from being used for items such as contact solution and bandages.
  • Penalty: Unlike FSAs, HSA funds carry over from year to year. So if you max out your HSA and don’t use the funds, you can find yourself with a rather large balance after a few years. You can withdraw the funds for other purposes, but face both income taxes AND a 10% penalty. Starting in 2011, that penalty will become 20%. Currently, the penalty does not apply to those over 65 – since the health care bill does not specifically address that provision, I’m assuming it will stay the same.

HSA Planning and Impacts

If you think you’ll need the money for healthcare expenses now or in the future (or long term care expenses down the road), an HSA is a great way to stash money that can later be used tax free. But if you are making contributions at the expense of retirement contributions or meeting other savings goals, you might want to rethink your strategy. The new penalty means that you could pay 45% on non-qualified withdrawals if you are in the 25% tax bracket. So be sure to save only what you need in an HSA.

In addition, you should stock up on non-prescription medicines before the end of 2010. Starting in 2011, ask your doctor to write
prescriptions if you have the choice between a prescription and non-prescription drug – this will allow you to run the expense through your HSA.

Check out the entire health care series: