Valerie L. Harman, CPA, CFP®
Tax & Financial Planner
A Health Savings Account (HSA) is a special bank account that allows you to pay for qualified medical expenses with pre-tax dollars. An HSA can be a great vehicle to reduce your total taxes and/or provide additional retirement savings. The only requirement to participate in an HSA is that your health insurance plan is a qualified high-deductible plan.
Paying qualified medical expenses from your HSA is a great way to make those expenses effectively tax deductible. Most taxpayers will not meet the threshold to deduct medical expenses on their tax returns; but 100% of qualified medical expenses paid from your HSA are effectively tax deductible because contributions to a health savings account are deducted from taxable income. As well, contributions made through payroll deductions reduce wages subject to Social Security and Medicare tax. For example, a taxpayer in the 22% Federal and 3.46% Ohio marginal tax brackets who makes a $3,500 HSA contribution through payroll deductions may reduce total taxes by approximately $1,159. Interest earned in an HSA is also not taxable.
An HSA can also be another source of retirement savings. Once you reach age 65, the funds can be withdrawn for any purpose; although distributions that are not used for qualified medical expenses will be subject to ordinary income tax, just like IRA distributions. However, you can continue to use the HSA for qualified medical expenses tax-free. If you are age 65 or older, Medicare premiums can be paid tax-free from the HSA (but not Medicare supplement plans). The HSA can also be used to reimburse yourself (tax-free) for any qualified out of pocket medical expenses going back to the date the HSA was first opened and the balance remained above $0.
Prior to reaching age 65, there is a 20% Federal tax penalty, as well as ordinary income tax, on HSA distributions used for anything other than qualified medical expenses. Qualified medical expenses include insurance copays and deductibles, medical, dental, vision, audiologist or therapist fees, lab work, medical devices and supplies, eyeglasses, hearing aids, prescriptions, first aid items such as bandages, and long-term care insurance premiums. Some items that do not qualify include cosmetic surgery and medical concierge fees.
If your health insurance plan is a qualified high deductible plan, you can make annual contributions up to $3,500 (single) or $7,000 (family) to an HSA for 2019. Those age 55 or older can make an additional $1,000 “catch-up” contribution. Contributions paid by your employer are included in the total limit calculation. Contributions are made either through payroll deduction or deposits directly at the bank. You will receive a debit card for the account which can be used to pay medical expenses. You could also choose to pay medical expenses out of pocket, and then reimburse yourself from your HSA by simply making a withdrawal. For tax purposes, it is important to keep receipts and records of amounts paid from your HSA. As long as you are in a qualified high-deductible health insurance plan, you do not need to be in an employer plan (some Marketplace plans may qualify) to open an HSA at any bank or financial institution which offers the accounts.
Medicare Parts A or B are not qualified high deductible plans. Once you receive Social Security benefits at age 65 or older or enroll in Medicare, you must stop HSA contributions. A qualified high-deductible health insurance plan for 2019 must have a deductible of at least $1,350 and up to a maximum $6,750 out of pocket limit for single coverage, or at least $2,700 deductible and up to a maximum $13,500 out of pocket limit for family coverage. Other plan requirements apply, so it is best to check with your insurer to make sure it is an HSA-eligible plan.
HSAs are not subject to the “use it or lose it” rule to which Flex Savings Accounts (FSAs) may be subject. Contributions can stay in the account your entire life and then pass to a beneficiary. If your spouse is the beneficiary, the HSA will become your spouse’s HSA. If the beneficiary is anyone other than a spouse, the account must be paid out in full after your passing as ordinary taxable income to the non-spouse beneficiary. A non-spouse beneficiary could potentially use the funds for qualified medical expenses within one year and exclude that amount from taxable income.
Health Savings Accounts can be a great component of tax and financial planning, but it is important to understand the HSA rules. Please contact our office if you would like to discuss including an HSA in your tax or financial planning.