How a Health Savings Account Works When You're Self-Employed

The plan has to come first

An HSA isn't insurance by itself. It sits next to a health plan that the IRS calls a high deductible health plan, or HDHP. The plan has to meet the IRS rules for deductibles and out-of-pocket costs, and the plan's own paperwork will usually say "HSA-eligible" when it does.

If you're shopping for your own coverage this Open Enrollment, that label is the thing to look for. If a plan doesn't carry it, an HSA won't work alongside it. My post on deductible vs out-of-pocket maximum explains the two numbers that matter most when you compare a high deductible plan to one with a lower deductible.

You open it yourself

When you have a W-2 job, the employer usually sets up the HSA. When you're self-employed, you pick a bank, credit union or other HSA trustee and open the account in your own name. The account stays yours. It doesn't depend on a job, and it doesn't disappear if you change plans later.

How the tax side works

Here is where an HSA can really help at tax time. The IRS describes three tax breaks in Publication 969:

• What you contribute can be deducted on your federal return, using Form 8889, even if you don't itemize.
• Interest or investment growth inside the account isn't taxed while it stays there.
• Withdrawals used for qualified medical expenses come out tax-free.

There's a catch if you use the money for something else. The IRS says withdrawals that aren't for qualified medical expenses are taxed as income and may also get an additional 20% tax. So treat the account as medical money, and keep your receipts.

The IRS sets a yearly limit on how much you can put in, with a higher limit for family coverage. Those limits change each year, so check the current figures in Publication 969 before you fund the account.

If you also deduct your health insurance premiums as a self-employed person, that's a separate deduction from your HSA contributions. I walk through it in my post on how self-employed people can deduct health insurance premiums.

The money rolls over

An HSA isn't use-it-or-lose-it. The IRS says you don't have to make withdrawals each year, so whatever you don't spend carries forward. For a lot of people who work for themselves, that turns the account into a cushion for a rough medical year down the road.

A few things that can trip people up

Rules about who can contribute are set by the IRS, and a few situations change things. Being enrolled in Medicare is one. Having other health coverage on top of your high deductible plan can be another. If either applies to you, read that section of Publication 969 or ask your tax pro before you contribute.

Talk with a tax professional about your own return. I can help with the coverage side and with spotting which plans are HSA-eligible.