Most tax benefits have symmetry. If you defer income in to a 401(k) or traditional IRA contributions are deductible and then your account distributions are taxable. Similarly, if your contributions are not deductible (i.e. a Roth IRA), your distributions are tax-free. Health Savings Accounts (HSAs) get the best of both worlds: contributions are tax deductible and account earnings and distributions can be tax-free!
Being eligible for an HSA is commonly misunderstood.
You don’t need anyone’s permission to establish a Health Savings Account (although your employer may establish and fund an HSA for you). You are the owner of the account and it’s not part of your health insurance. The funds don’t have to be spent annually like a Flexible Spending Account, where you “use or lose it.” A Health Savings Account is similar to an IRA and is established and invested at a “qualified custodian”. This is typically a bank, insurance company, or brokerage firm. Think of your HSA as an extra retirement account or a special purpose medical expense emergency fund.
How do you know if you are eligible for an HSA?
Your health insurance must be a qualifying “high-deductible health plan” (HDHP). For individual coverage, that means health insurance with at least a $1,400 annual deductible and $6,900 maximum out-of-pocket. For family coverage, it must be at least a $2,800 annual deductible and $13,800 maximum out-of-pocket. By the way, if you are enrolled in Medicare, no HSA contributions are allowed.
If you have individual coverage, you can contribute $3,550 for 2020. For family-coverage, it’s $7,100. 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.
Why it gets even better
Distributions from an HSA that are for “qualified medical expenses” are not taxable distributions. Qualified medical expenses are expenses that are not covered by insurance, that would be deductible on your tax return (although most people don’t have enough to exceed the deduction threshold). Eyeglasses, dental expenses, co-pays, etc. qualify. 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 Health Savings Account distributions for non-qualified medical expenses, you will pay tax on the distribution and a 20% penalty if you are under 65. This penalty goes away after 65. This penalty going away at 65 means you could be 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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