What is a Health Savings Account (HSA)?
Congress created Health Savings Accounts in 2003. The idea is to couple an HSA with a high deductible health insurance plan- HDHP. That way the taxpayer can accumulate the deductible with before tax dollars.
A HDHP is one that has deductibles of at least $1350 for individual coverage or $2700 for family coverage. Generally employers offer HDHPs to save on premium expense while still providing health insurance coverage. Healthcare exchange policies also qualify for HSA usage.
How Much Can I Contribute?
To be able to contribute, the taxpayer must not have any other health insurance apart from the HDHP. This means Medicare beneficiaries aren’t eligible to contribute. Dental, vision, and long-term care insurances are not considered other health insurance and do not affect eligibility.
The deferral maximum into a HDHP is up to $3,450 for an individual and up to $6,850 for a family. Both you and your employer can contribute, but the annual contribution limits still stand no matter who puts the money in. Those over age 55 can contribute an additional $1000. Taxpayers have until April 15 to make last year’s contribution. Notably, contributions may very well exceed the plan’s annual deductible. Typically, the higher the deductible the lower the premium, and vice-versa.
IRA to HSA Transfer
Since 2006, taxpayers can make a once-in-a-lifetime tax-free distribution from an IRA to a HSA in the amount of the maximum yearly contribution for that year.
Do you lose any funds left over at the end of the year? No! That is the case with the FSA – the Flexible Spending Account. With the HSA you invest unused funds and they accumulate year after year.
How Do I Invest my Accumulated Funds?
The owner of the HSA chooses IRA- type investments such as CDs, stocks, bonds, and mutual funds. Investments in real estate and precious metals are permissible. No life insurance is allowed. An HSA at a previous employer can be rolled into an HSA at a new employer. HSAs cannot, however, be rolled into IRAs or workplace retirement accounts, such as 401(k)s or profit-sharing plans.
HSA distributions are one of those rare tax circumstances where money is saved before tax and then not taxed when distributed. Withdrawals are income tax free if made for qualified medical expenses, including medical insurance deductibles and co-insurance amounts. Other allowable tax-free distributions are for dental, vision, hearing, and chiropractic care. Expenses for durable medical equipment qualify, as do transportation expenses related to medical care.
Once you are age 65 you can use your HSA to pay for long-term care insurance premiums, COBRA premiums, and certain Medicare expenses, including premiums for Part B and Part D prescription-drug coverage. This is huge! You can use before-tax dollars to pay for your LTC policy! Medigap policy premiums are not eligible, though.
It is up to the taxpayer to retain records to substantiate the tax-free withdrawal. It is perfectly fine to make non medical expense withdrawals – it is your money – but those amounts are fully taxable, with a 20% penalty up until age 65. In other words, once you hit age 65, the taxation of non-medical withdrawals from your HSA is identical to that of your traditional IRA.
These are your funds, and you name a beneficiary to receive them at your death. When you die any unused funds pass to that beneficiary after paying all final medical expenses. If that is your spouse, the transfer is tax-free. If someone other than a spouse, the account becomes taxable to that beneficiary. Taxes must be paid that year. There is no stretch provision as with inherited retirement accounts.
The HSA is the only vehicle I can think of that gives a triple tax benefit:
- Deduction on the way in
- Earnings not taxed year by year
- No taxation upon distribution for qualified medical expenses
Both Roth IRAs and 529 plans give a double tax benefit: no taxation on growth nor at distribution.
Glenn J. Downing is a CERTIFIED FINANCIAL PLANNER™ professional and co-founder of CameronDowning, a Registered Investment Advisory Firm in Miami, FL. Please connect with us on LinkedIn, Facebook, Instagram, and Twitter. Also, check out the rest of the CameronDowning website where you can see dozens of short videos answering many of your personal financial questions. Feel free to email questions to [email protected]