How Health Savings Accounts Work

HSA Eligibility Rules and Contribution Limits

The tax benefits of health savings accounts are amazing, so why aren't we all signed up? Because the IRS has strict rules about who is eligible to use HSAs. Here are the most important criteria for HSA eligibility:

  • You must be enrolled in a high deductible health plan (HDHP) with no other health coverage.
  • You cannot be enrolled in Medicare.
  • You cannot be claimed as a dependent on anyone else's tax return.

First things first, what qualifies as a HDHP? An HDHP, according to the IRS, must have both a higher-then-average deductible and a high out-of-pocket limit. Here are the eligibility rules for tax year 2014:

  • Minimum annual deductible: $1,250 for single coverage, $2,500 for family coverage
  • Maximum out-of-pocket spending: $6,350 for single coverage, $12,700 for family coverage

If you're unsure if your health plan qualifies as an HDHP, ask your human resources representative or call the insurance provider directly. Here's a tip: Some HDHPs go by the name consumer-directed health plans (CDHPs).

Next are the HSA contribution limits. The IRS puts a limit on how much money you can divert tax-free into an HSA annually. For the 2014 tax year, the contribution limit for self-coverage is $3,300 and up to $6,550 for family coverage. Folks over 55 can contribute an additional $1,000. Any money that you contribute in excess of those limits will be taxed as income plus a 6 percent excise tax if you don't spend it by April 15 of the following year [source: IRS].

Here comes the confusing part (this is the IRS, after all). You are considered eligible to invest in an HSA for the entire tax year even if you only become eligible on Dec. 1 of that year. So if you enroll in a qualifying HDHP in November 2014 and open an HSA on Dec. 1, you can contribute the full $3,300 or $6,500 tax-free for the 2014 tax year. This called the last month rule [source: IRS].

However, there's also something called a testing period. You must remain eligible for 12 consecutive months after you begin contributing to the HSA or any money you invested in the account will be taxed as income plus a 10 percent penalty [source: IRS]. Ways you could lose eligibility include switching to a low deductible health plan, enrolling in Medicare or qualifying as a dependent on someone else's tax return.

When tax day arrives, you will need to enter all HSA contributions on Form 8889. To help you out, the bank or other trustee managing your HSA account will mail you Form 5498 listing your total HSA contributions for the year. If your employer also made contributions, they will be listed in box 12 on your W-2 form.

On the next page, we'll explain how HSAs can double as retirement accounts.