As you complete your tax planning for this year (and continue to plan for the future), it is important to take the time to consider the many advantages associated with utilizing a Health Savings Account (HSA). If you are looking for additional ways to lower your taxable income through tax-advantaged savings account, an HSA might be just the thing you need.

Here is some important information that you will need to know in order to determine whether an HSA is a good option for you:

What is a Health Savings Account?

A Health Savings Account (HSA) is a tax-advantaged vehicle for saving money on healthcare expenses. You receive a tax deduction for your contributions to an HSA, and the money in the account grows tax-free as long as you use the funds for qualified expenses.

Be aware that you must meet certain eligibility requirements in order to open an HSA. In order to qualify, you must have a high-deductible health plan, meaning that your deductible must be at least $1,200 a year if you are on an individual plan ($2,400 a year if you are on a family plan). Also, required out-of-pocket maximums should not exceed $6,050 for individuals ($12,100 for families).

Funds from your Health Savings Account can be used on such healthcare expenses as prescriptions, doctor visits and co-pays, dental services and eye care services. You can also use your HSA to pay COBRA premiums, or other health insurance premiums if you are unemployed. (If you are employed, you cannot use your HSA to pay premiums.)

Using an HSA to Reduce Your Tax Liability

Because your HSA contributions are tax-deductible, you can lower your taxable income by making those contributions. For a taxpayer with a high enough adjusted gross income, an HSA can be a major help. This is because it can be difficult to spend enough on healthcare expenses to reach the point where they exceed 7.5% of your AGI (which will be raised to 10% of AGI in the near future, due to the health care reform bill passed in 2010).

However, by contributing to a HSA and then paying for healthcare costs with funds from your account, you are basically converting all of your healthcare expenses into tax-deductible expenses. This can help you avert the AGI requirement quite nicely, and will help you lower your tax liability.

It is important to note that there are some limits on HSA contributions. In 2011, the limit is $3,050 for an individual and $6,150 for families. In 2012, that limit will be adjusted for inflation and raised to $3,100 for individuals and $6,250 for families. Those over the age of 55 can add a $1,000 annual catch-up contribution for 2011 and for 2012.

Penalties for Withdrawals

As long as you are using your withdrawals to pay for qualified expenses, you do not have to worry about IRS penalties. However, once you begin withdrawing funds for items other than qualified healthcare expenses, your HSA starts behaving a lot like a traditional IRA. If you are under the age of 59½, you will be hit with a 20% penalty, and you will have to pay income tax on the amount that you withdraw. If you are 65 or older, you can withdraw for non-medical expenses without incurring a penalty (also if you are disabled at the time of the withdrawal), but you will still have to pay income tax on the amount that you withdraw.

If you can handle the high deductible, and your family has few medical expenses, an HSA can provide another tax-advantaged account to decrease your tax liability. As always, if you’re having difficulty determining whether or not an HSA is a viable option for you, consult a tax professional.