Author: Darrell R. Tierney CFP® CPA PFS
Let’s talk about one of the best Federal income tax benefits available. Most tax benefits are symmetrical. If your account contributions are deductible (i.e. a traditional IRA), your account distributions are taxable. Similarly, if your contributions are nondeductible (i.e. a Roth IRA), your distributions are tax-free. If you are eligible, a Health Savings Account (HSA) is tax nirvana. Contributions are tax deductible, and account earnings and distributions are tax-free.
HSA eligibility is commonly misunderstood.
You don’t need IRS, employer or your mom’s permission (although your employer may establish and fund an HSA). You own the account and it’s not part of your health insurance. The funds don’t have to be spent annually, where you “use or lose it.” The account is similar to an IRA and is established and invested at a “qualified custodian”-usually a bank, insurance company or brokerage firm. Think of your HSA as an extra retirement account or a special purpose medical expense emergency fund.
To be eligible, your health insurance must…
…be a “High Deductible Health Plan” (HDHP). For individual coverage, that means health insurance with least $1,300 annual deductible and $6,550 maximum out of pocket. For family coverage, $2,600 annual deductible and $13,100 maximum out of pocket. By the way, if you are eligible for Medicare, no HSA contributions are allowed.
Like all good things there are limits.
If you have individual coverage, you can contribute $3,350 for 2016. For family-coverage, it’s $6,750. If you are over 55, you can contribute an extra $1,000. Similar to an IRA, you have until April 15th of the year following to make your annual deductible contribution.
Here comes the good part.
Distributions from an HSA that are for “qualified medical expenses” are not taxed. These are medical expenses that are not covered by insurance, and that would be deductible on your tax return (although most people don’t ever have enough to exceed the deduction threshold). Think eyeglasses, dental, co-pays, etc. You can even use your HSA to pay long term care premiums and health insurance if you are on COBRA, or are receiving unemployment.
If you take out money for things that are not for qualified medical expenses, you’ll pay tax on the distribution and a 20% penalty if you are under 65. The penalty goes away after 65. Consider using your HSA as a retirement savings tool (similar to an IRA). Unlike an IRA or 401(k), HSA’s have no required minimum distributions at age 70, so taxes can be deferred much longer. After death, your surviving spouse can take over the HSA and keep using it. A non-spouse beneficiary will pay tax on the account value at death.
As with most tax planning ideas, things can get complicated quickly. Call us, we’re here to help.
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