Health Savings Accounts
In recent months, health care reform has been receiving a lot of attention in the media. Congress has promised to pass healthcare reform and something Americans are likely to hear more and more about are health savings accounts. A health savings account (HSA) is a savings account that allows an individual or family to set aside funds for current and future medical expenses. What makes this savings account different from other accounts is that it offers significant tax benefits.
Only certain individuals are eligible to establish a HSA. In order to qualify, an individual or family must have a high deductible health plan. A high deductible health plan is defined as a plan with a minimum deductible of $1,300 for individuals and $2,600 for families in 2017. In addition to that, the maximum out-of-pocket costs under the plan are $6,550 for individuals and $13,100 for families. Special rules apply if some members of a family are covered by a high deductible health plan and some are not. If you can be claimed as a dependent on another individual’s tax return, are age 65 or older and enrolled in Medicare, or are already covered by a plan that does not qualify as a high deductible health plan, you are not eligible to establish a HSA.
How to Establish a HSA and Make Contributions
Once you have a high deductible health plan in place, you can establish a HSA through a qualified HSA administrator such as a bank or other financial institution. If you have a group high deductible health plan through your employer, your employer may offer a HSA option. Before going with the employer-provided option, always make sure to shop around for the best HSA as administrators may have different fees and options available. Some administrators may offer only basic interest while others even offer investment options, which will be discussed later.
Contributions must be made in cash and can be made directly to a HSA account or through payroll deduction if your employer offers that option. For those individuals who have group coverage, your employer may even make HSA contributions as part of your compensation. In 2017, the contribution limit for individuals is $3,400 per year. For families, the contribution limit is $6,750 per year. Those who are 55 or older can contribute an additional $1,000 per year. Bear in mind, the year an individual or their spouse turns age 65 and is eligible for Medicare, there are limitations on the contributions limits. It is important to remember, in any year you contribute more than the IRS limits, an excise tax will apply.
The Triple Play
Anyone who is familiar with baseball knows perhaps the most difficult defensive play to accomplish is the triple play. The defense has to get three runners from the offense out before they reach the next base safely. For the average American though, accomplishing the “triple play” is not that difficult when you can use a HSA. With a HSA triple play, contributions are tax deductible, any earnings are tax-deferred, and any distributions used for qualified medical expenses are tax-free. In the year you make HSA contributions, you will report the contributions as an above-the-line deduction on your federal income tax return. Distributions will be reported on your tax return in the year they occur. One important item to note is that if you pay for qualified medical expenses using HSA funds, you cannot itemize those medical expenses on Schedule A of your tax return.
How to Use a HSA
Funds from a HSA can be used for qualified medical expenses as mentioned above. Qualified medical expenses include items such as deductibles and co-pays, laboratory fees, prescriptions, dental treatment, eyeglasses, and hearing aids. Items such as over-the-counter medications do not qualify as qualified medical expenses.
What if you do not need your HSA funds in the current year for medical expenses? A HSA allows you to build a war chest for future medical expenses as the “use it or lose it” policies found with flexible spending accounts do not apply. This is a great way to set aside funds for medical expenses later in life, such as retirement, when most individuals incur larger medical expenses. This is why it is important to shop around for the best HSA administrator, because many administrators will allow an individual to invest a portion of their HSA in securities such as mutual funds and reap the benefits of compounding. If you have funds in your HSA and are no longer eligible to contribute because you are enrolled in Medicare, you can still continue to use the HSA for qualified medical expenses and even to pay Medicare premiums. For those who are fortunate enough to be able to invest the funds in their HSA, it is important to remember to always set aside enough cash in the account to pay for current out-of-pocket medical expenses should you incur high medical expenses in a given year.
For many people, life does not always go the way you want it and you may find yourself having to make a withdrawal from the HSA for nonqualified medical expenses. If this happens, the distribution will be considered taxable and an additional 20 percent penalty tax will apply. The 20 percent penalty tax does not apply for those 65 or older.
Options for Self-Employed Individuals
For self-employed individuals, you may be able to establish a high deductible health plan through your business and make HSA contributions directly from your business. This can be a great way to reduce the taxable income for your business while setting aside funds for healthcare. It is important to note, there are additional tax requirements and nondiscrimination rules that may apply for individuals who want to choose this option, so always consult with your tax advisor first before establishing a HSA option for your business.
HSAs are a great vehicle for setting aside money for current and future medical expenses. It allows an individual to take advantage of the rare tax triple play. River Capital Advisors, L.C. and Smoak, Davis, and Nixon, L.L.P. have the expertise to guide individuals and families through the rules surrounding HSAs and other areas of financial planning. Feel free to contact us to discuss your situation.
The content of this article is based on current law governing health savings accounts.