HSAs, or Health Savings Accounts, are gaining in popularity. But is it the right choice for you? In this post I’ll discuss the in’s and out’s of HSAs and lay out the case for why you should consider contributing to one.
In this post we’ll discuss:
- What is a Health Savings Account (HSA)
- Who Qualifies to Contribute to an HSA
- Tax Benefits of an HSA
- How an HSA Fits Into Your Overall Retirement Plan
So let’s get to it!
What is a Health Savings Account?
A Health Savings Account, or HSA, is a special type of account that has specific tax benefits that relate to saving, spending and being reimbursed for qualified medical expenses. For you fellow geeks out there, the relevant section of the Internal Revenue Service (IRC) is section 223.
In other words, if you’re going to be spending money on health care (everyone will at some level, at some point) then you might be able to use pre-tax money to pay for those expenses.
I’ve written previously about how awesome I think Roth IRAs are due to the fantastic tax benefits. You can read more in the blog post Why the ROTH IRA is the Greatest Thing Since Sliced Bread. Well look out Roth IRA because the HSA has issued a challenge!
Because of a little something we call Triple Tax Free.
- Contributions (up to an annual limit) may be tax-deductible (pre-tax)
- Earnings generated by the HSA are not taxable within the HSA
- Distributions from an HSA used to pay qualifying medical expenses are EXCLUDED from taxable income
Is this real life?
Who Qualifies to Contribute to a HSA?
Qualifying individuals with high-deductible health plans, or HDHP, can make tax-deductible cash contributions that may be used to reimburse the individual TAX FREE for qualifying medical expenses.
Who’s a qualifying individual?
- Someone who is subject to a high-deductible health plan
- Someone NOT eligible for Medicare benefits
- Someone NOT claimed as a dependent on another’s tax return
For 2017, a high-deductible health plan for an HSA is defined as following:
Single Greater than or equal to $1,300 $6,550
Family Greater than or equal to $2,600 $13,100
With current health insurance costs seeing large increases, many are opting for higher deductibles as a way to lower the monthly premium, meaning more people are qualified to contribute to an HSA.
Also, you don’t need this account set up by your employer; you can set one up all on your own. However, if an employer does make contributions to an HSA for you, the amount is not included in your income.
The amount you can contribute for 2017 (limits) are $3,400 for single coverage and $6,750 for family coverage. For those between the age of 55-65, an extra $1,000 contribution is allowed. HSAs have a maximum monthly contribution amount, which is 1/12 of $3,400 for single coverage and 1/12 of $6,750 for family coverage. However, there is a special rule called the last-month rule.
The last-month rule states that a person who is eligible for an HSA on December 1 is considered an eligible individual for the entire year. That means you can make an HSA contribution for the entire year. However, you will be subject to a testing period, where you must remain an eligible individual for the entire period, which runs through December 31 of the following year. If you do not remain eligible, special recapture rules (paying tax) will apply.
Contributions over the limits are not deductible and you will actually incur a 6% penalty on the overage amount every year until you correct the overage.
Tax Benefits of an HSA
I don’t think I can overstate how great the tax benefits are with a Health Savings Account. Triple Tax Free really speaks for itself!
You do need to be careful however, because withdrawing money from an HSA for non-qualified expenses and before a certain age will result in taxes and potential penalties. In fact, withdrawals for expenses other than qualifying medical expenses are subject to income tax and a 20% penalty. This penalty does not apply after age 65. (More on this fun fact in the next section)
Qualified medical expenses generally include expenses that are deductible as itemized deductions on your tax return. Here’s a list from HSA Center of potential eligible and non eligible medical expenses.
How an HSA Fits Into Your Overall Retirement Plan
HSAs may just be the golden gun of your retirement plan. Fidelity estimates that a 65-year old couple retiring in 2016 will likely need $260,000 for healthcare related expenses over the course of their retirement. This is for things like insurance coverage, out of pocket expenses, etc. Increased healthcare is generally a guaranteed expense people will have in retirement so it pays to plan ahead for these costs.
That’s why the HSA is so great.
First the Triple Tax Free nature of paying for qualified medical expenses is fantastic.
Secondly, after age 65, the 20% penalty no longer applies and you can use the money for ANY expense (you just need to pay income tax). This is a big deal. Basically, the HSA acts as another IRA account where your money grows tax-deferred until you withdraw it in retirement. Since the annual (2017) contribution for a traditional IRA is limited to $5,500 ($1,000 catch-up), the HSA gives you a place to possibly sock away more tax-deferred money.
Individuals can even make a one-time direct rollover from an IRA (not SIMPLE or SEP) to an HSA. There is no deduction allowed for the amount and it is limited to the annual maximum contribution that can be made to an HSA. It’s also subject to the special tax recapture rules.
You can even invest the funds in your HSA in the markets using funds like Vanguard to grow your HSA savings over time.
Are HSAs Right For You?
Given the Triple Tax Free nature and the ability to save more money in a tax-deferred manner, an HSA is worth serious consideration in your retirement plan.
Have additional questions or wonder how to get started? I make it easy to get answers. Just shoot me a quick message using my confidential contact form and I’ll get back to you with a friendly reply within 48 hours.
Best of Success,
Work With John
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