If you don’t know about Health Savings Accounts (HSA’s) and are eligible to open one, you’re missing out on an excellent savings vehicle with fantastic tax benefits. HSA’s have been around for about 15 years, but it isn’t until the last few years that they are getting more widely adopted -word is getting out about how valuable they are as a long-term savings vehicle for certain individuals.
What is an HSA?
An HSA is a tax-exempt trust or custodial account established with a bank, insurance company or other IRS-approved entity. They are triple tax-advantaged – contributions are pre-tax/tax-deductible, earnings grow tax-free, and withdrawals are tax-free if used for qualified medical expenses. Hence, the triple tax savings.
These accounts are for medical expenses, but you don’t have to use up the balance during the year. Unused balances roll over from year to year, and you can invest the money for growth. For people who have adequate cash flow, low to average health care costs, and pay high taxes – the best way to use HSA’s is as a long-term savings account for medical expenses in retirement. In this case, you will benefit most from opening an HSA that has good investment options – low-cost ETF’s and mutual funds and take full advantage of compounding growth of your funds.
You must be an “eligible individual” to qualify for an HSA, which means that:
- You must have a high-deductible health plan (HDHP). The IRS definition of a “high-deductible” plan in 2018 is a policy with a deductible of at least $1,350 per individual or $2,700 for a family, and whose out-of-pocket maximum is at most $6,650 or $13,300 (individual/family).
You can enroll in a high-deductible health plan through your employer, or on your own as an employee or a self-employed individual. There can be advantages to joining your employer’s plan: if the HSA is part of a Section 125 cafeteria plan and administered by a payroll deduction, the contributions will not only be Federal tax-free, they will be free of FICA taxes as well – an additional tax savings of 7.65%. Your employer may make contributions on your behalf that aren’t counted against your maximum contribution and are exempt from FICA taxes as well. Self-employed individuals do not avoid FICA taxes with their contributions to an HSA. Each State taxes HSA’s differently. For example, California prohibits a state tax deduction for an HSA contribution.
- You cannot have other health-care coverage except what the IRS considers permissible coverage, for example,plans with limited coverage, such as dental or vision plans.
- You can’t be a Medicare recipient. Some people who are still working at age 65 delay Medicare so they can continue contributing to an HSA -this could be a good strategy for certain individuals.
- You can’t be a dependent on someone else’s income tax return.
If you qualify, you can contribute as much as $3,450 to an HSA in 2018 if you have individual health coverage, or $6,900 if you have a family health plan. Moreover, if you’re 55 or older, you can contribute an additional $1,000 as a catch-up contribution. Contribution amounts can be flexible and can be made any time during the year up to the tax-filing deadline in April of the next year.
The money in your HSA remains available for future qualified medical expenses even if you change health insurance plans, change employers or retire. Funds left in your account continue to grow tax-free.
What medical expenses are eligible?
You would use your HSA funds for health expenses that aren’t covered by your traditional health insurance, and many are eligible*, for example:
- Alcoholism treatment
- Ambulance services
- Contact lens supplies
- Dental treatments
- Diagnostic services
- Doctor’s fees
- Eye exams, glasses, and surgery
- Fertility services
- Guide dogs
- Hearing aids and batteries
- Hospital services
- Lab fees
- Prescription medications
- Nursing services
- Psychiatric care
- Telephone equipment for the visually or hearing impaired
- Therapy or counseling
*For a full list, look at IRS publication 502.
Whether you have a self-only or a family health insurance policy, HSA money may be spent on medical expenses for you, your spouse and current tax dependents.
You can’t pay medical insurance premiums out of your HSA. However, HSAs can pay for premiums for long-term care insurance (subject to certain limits*); health-care continuation coverage (e.g. COBRA); health-care coverage while receiving federal or state unemployment compensation; and Medicare parts A, B, D , Medicare HMO, and Medicare Advantage Plan premiums, if you’re at least 65. HSA’s cannot be used to cover Medigap premiums.
*Limits for reimbursement of Long-Term Care Premiums From HSA
- Attained Age Before Close of Taxable Year 2018 Limit
- More than 40 but not more than 50 $780
- More than 50 but not more than $1,560
- More than 60 but not more than 70 $4,160
- More than 70 $5,200
Penalties for Non-Compliance
The penalty for taking a non-qualified withdrawal from an HSA is high – you must pay tax plus a 20% penalty if you are under age 65. So the triple-tax benefit is broken. If you are over 65, there is no penalty on non-qualified withdrawals, but taxes apply in the year of the withdrawal.
Mechanics of Opening An Account and Using It
You must have a HDHP before you can sign up for a Health Savings Account. Besides working with your employer’s option if you are an employee, many institutions offer HSA’s including insurance companies, banks, or credit unions. You can search the internet for HSA providers.
Depending on the HSA, reimbursements are made by check, ACH transfer, or ATM withdrawal. Good recordkeeping is critical because there is no time restrictions or deadlines for when you can reimburse yourself from the account. You have to keep your receipts to document the date of purchase and also as proof the expense is qualified. Medical expenses you incurred before the HSA was open aren’t eligible.
Some HSAs charge monthly maintenance or per-transaction fees, which vary by institution. Some providers waive the fees if you maintain a certain minimum balance. So, it pays to shop around.
What happens to your HSA when you die?
If you designate someone other than a spouse as a beneficiary, the fair market value of the account on the date of death is taxable to the recipient in the year of your death. If your beneficiary is your spouse, he/she can use the HSA are their own. If you die without a designated beneficiary, the value goes into your estate and is includable on your final tax return.
As you can see, there are many benefits to HSA’s, here are a few more that are unique to this savings vehicle:
- There are no maximum income thresholds that you can disqualify you from opening an HSA.
- There are no Required Minimum Distributions (RMD’s) starting at age 70 1/2.
- You can be unemployed and contribute to an HSA.
I think you can agree that if you can afford to pay your uncovered medical expenses out of pocket now, and can fully fund your HSA every year invested for growth, you will have a nice nest-egg for health expenses when you are no longer working.