Hooray for the HSA

HSA Intro

A Health Savings Account (HSA) is a medical savings account with a multitude of tax advantages. Established in 2003 for the 2004 tax year, the popularity of HSAs has exploded in recent years, as health insurance premiums continue to rise over time. Although more and more consumers have turned to HSAs as a means to bring down and control their health care costs, HSAs are still overlooked as a retirement investment tool. With proper planning, HSAs are capable of offering a trifecta of tax benefits to be discussed later in this newsletter.

Who is Eligible for HSAs?

To qualify for an HSA, consumers have to be enrolled in a high-deductible health plan with annual deductibles of at least $1,300 for individual coverage and $2,600 for families. The plan must also have maximum annual out-of-pocket costs of $6,550 for individuals and $13,100 for families. Approximately 20 million Americans are covered under HSA eligible insurance plans.

Benefits

HSAs offer a triple tax advantage to account owners:

• Pretax investment: HSAs provide the same tax-deferral benefits as a traditional IRA or 401(k). HSA contributions can be tax deductible or excluded from gross income. HSA contributions lower your adjusted gross income and are tax deductible before you turn 65 and become eligible for Medicare. In parallel to the federal deductions, contributions to HSAs are tax exempt or deductible in most states, with the exceptions of Alabama, California, and New Jersey.
• Tax free growth and savings benefits for those who are healthy enough or financially capable to not use the accumulated balances to pay for medical expenses: Earnings inside an HSA account accumulate tax free.
• Tax distributions: HSAs provide the tax-free withdrawal benefits of a Roth IRA. In fact, withdrawals from an HSA account can be fully excluded as long as they are used to pay for qualified medical expenses at any age. Qualified medical expenses are those expenses that generally would qualify for the medical and dental expenses deduction. These are further explained in IRS Pub. 502.

HSAs also provide additional flexibilities to account owners:

• Unlike flexible spending accounts, HSA funds are rolled over from year-to-year, meaning you do not lose the unused balance in an HSA at the end of the year. Instead, the ending balance is carried forward to the following year.
• An HSA is “portable,” which means that it is not tied to the employer. Thus, HSA owners can move their savings to another provider.
• You can claim a tax deduction for contributions you, your employer, or someone else made to your HSA even if you don’t itemize your deductions on Schedule A of your Form 1040.
• HSAs provide taxpayers with a supplemental annual retirement savings, especially when they have maxed out their conventional retirement plans.

Limitations

• You have to be enrolled in a high-deductible health plan in order to qualify for HSA contributions.
  – Many HDHPs are not HSA-eligible.
• Non-qualified withdrawals (usually non-medical expenses) are subject to income tax, and any early distributions, taken before the account owner turns 65 years old, are subject to income tax and a significant 20% penalty.
• Under current law, the contribution limits are low and thus cannot constitute an exclusive retirement strategy. The maximum amount that can be contributed to an HSA for the year 2017, including employer contributions, is $3,400 for individuals and $6,750 for family coverage. Account holders age 55 and older can stash away an extra $1,000, which can be referred to as “catch-up provision” coverage. The contribution limits are currently adjusted annually for inflation. However, this may change as the result of healthcare reform.

Outlook of HSA & Healthcare Reform

Based on current tax reform proposals, it is safe to say that HSAs are viable strategies for the foreseeable future. If it survives the senate, a key provision of the American Health Care Act, as approved by the House of Representatives on May 4, 2017, will enhance HSAs as it seeks to:

• Almost double the contributions limit to equal the limit on out-of-pocket cost sharing under qualified high deductible health plans to $6,550 for individuals and $13,100 for families, indexed for inflation.
• Extend an additional catch up contribution of up to $1,000 to the spouse over age 55.
• Expand the definition of qualified medical expenses to include expenses such as over-the-counter medications.
• Reduce the tax penalty for HSA withdrawals used for non-qualified expenses from 20% to 10%.

Conclusion

Investing in a health savings account, when eligible to do so, in conjuncture with retirement accounts such as 401(k)s and IRAs, is a powerful supplemental way to build your retirement savings while minimizing your tax burden. The HSA can be a triple tax tactic, with a tax break on contributions, growth, and distributions. The potential IRS penalties and income tax imposed on non-qualified withdrawals can be consequential, but may be avoided with proper planning.