Brad Cantrill, CFP ®, JD*
When most people think about Health Savings Accounts (HSA) they view them as a practical way to pay for out-of-pocket medical expenses. Paired with a high deductible health plan the combination of lower monthly medical premiums and tax savings on qualified medical costs make these an affordable option to address health care.
IRS Publication 969 governs the rules surrounding HSA and other tax favored health care plans. Used correctly, they have a triple tax benefit of a deduction, a deferral, and a tax-free distribution to pay for any qualified medical expenses Publication 502.
To qualify as an HSA, there must be a minimum plan deductible of $1350 for an individual or $2750 for a family. Each year $3450 can be contributed on an individual basis or $6900 for a family plan. There is also a $1000 catch-up provision for those over 55. One catch-up contribution is allowed per account, though it is possible for a family to have multiple accounts and catch-up contributions.
While there is no denying the utility of paying for current medical expenses on a tax-free basis, taking a long-term approach with your HSA dollars could create even more flexibility for health care, financial planning, or retirement needs. Let’s examine some of the many uses and I think you’ll be able to see why an HSA is like a swiss army knife in terms of functionality.
HSA can be building blocks for a strong emergency fund: Although a HSA cannot pay for medical premiums, these rules do not apply when someone is unemployed. COBRA payments or any other continuation or short-term medical plan meets the definition of a qualified medical expense. Using tax-free funds to stay insured while minimizing cash outflows could be a great risk mitigator if you are going through a job change.
HSA can be seeded with funds from an IRA: If your starting a new HSA, one of the best ways to fund one is from an existing IRA. The IRS allows a one-time rollover without penalty to a HSA not to exceed the annual contribution limits. This is a great way to move tax deducted funds into an account that has potential for a tax-free withdrawal.
HSA defer taxes, but doesn’t force you to take the money out: Funds in a HSA can be invested in the market for growth and any increase grows tax deferred until a distribution event occurs. Unlike an IRA though, there are no required or forced minimum distributions. After 65, the 20% penalty no longer applies to nonqualified medical expenses and only income taxes are due on investment gains. With no rules as to timing of distributions it can be a superior tax deferred investment vehicle vs. a Traditional IRA.
HSA receive a step up in basis for a spousal beneficiary: A married HSA owner will receive as step-up in basis in the account value so long as the spouse is the named beneficiary on the account. If the spouse is over 65, they essentially receive a tax-free account at the death of the spouse with only future gains subject to taxation. Non spouse beneficiaries do not fare as well, as taxes are due in the year of the death of the HSA owner.
HSA can pay for Medicare and long-term care premiums: While HSA cannot be used to pay for medical premium while employed, this does not apply to people who go on Medicare. A Medicare enrollee cannot contribute anymore to a HSA, but they can use the funds to pay for future Medicare premiums as well as Medicare advantage plans. They cannot however use HSA dollars to pay for a Medigap supplemental program. Tax qualified long-term care policies also meet the definition of a qualified medical expense. The participants age determines a premium amount for that can be paid with HSA dollars. This is another great way to pay portions of insurance premiums.
So when you are evaluating the best use of your discretionary income for savings don’t overlook the power of a HSA account. It does way more than just pay for qualified medical expenses.