The recent presidential election has caused many people to take a hard look at their positions on the various hotly debated social and political issues in this country. One of the issues that rarely escapes conversation is the ever-changing healthcare landscape. Whether you prefer a minimally regulated healthcare system left to the open markets, a single-payer system established and managed by the federal government, or any conceivable version in between, there are a few things that we can probably all agree on: features and benefits of coverage seem to change often and unexpectedly, premiums are painfully high, and the projected premium increases aren’t fostering any loyalty to the system in its current state.
As insurance premiums and costs of care jump each year, it becomes more important to find ways to mitigate the effects of those increases on your cash flow. One way to accomplish this is by using a health savings account (HSA).
These tax-advantaged savings vehicles offer a “triple tax benefit.” Here’s the breakdown:
- First, contributions made to HSAs are excluded from your federal taxable income in the year they are made. This is similar to the federal treatment of 401(k) and IRA contributions.
- Once inside the HSA, contributions can be invested, and the earnings on those investments grow tax-free.
- Finally, withdrawals from an HSA are tax-free if used for qualifying medical expenses, which can be generally described as those expenses that qualify as an itemized deduction on Schedule A of your federal tax return, which includes Medicare (but not Medigap) premiums. The penalty for using HSA funds for other-than qualified expenses is that the distribution will be subject to ordinary income tax and a 20 percent penalty.
This makes HSAs different from other tax-advantaged savings methods such as IRAs and 401(k) accounts. Generally, the tax code only allows you to defer paying tax on income, not to exclude it entirely. For example, an IRA or 401(k) enables you to exclude the portion of your income that you contribute to these accounts each year, but that income will eventually be taxed when you take distributions from the account. A Roth IRA allows for tax-free withdrawals, but the contributions have to be made with money that has already been taxed.
An HSA is therefore a fantastic way to save for (and reimburse) medical expenses now and in retirement. And in retirement? That’s right, HSAs can be used to pay for qualified medical expenses at any time, pre- or post-retirement. And, after age 65 (or after becoming disabled), the 20 percent penalty for nonqualified distributions no longer applies. Distributions for non-medical expenses, however, would be subject to ordinary income tax—the same as if the funds were distributed from an IRA or other retirement account.
Other benefits worth mentioning:
- There are no required minimum distributions at any age.
- If an employer chooses to make contributions to an individual’s HSA, those contributions are not treated as taxable income to the employee.
- No “use it or lose it” rule like a Flexible Spending Arrangement (FSA). Any value remaining in an HSA at the end of the year continues to grow and remains available to the account owner.
- At the death of the owner, an HSA can be rolled over to a surviving spouse and be treated as if it were his or her own.
Before settling on an HSA, you should compare your health care plan’s total cost of premiums plus out-of-pocket expenses for a traditional health plan to those of the high deductible/HSA plan.
To be eligible to fund an HSA, an individual must meet all of the following criteria (for 2017):
- Be covered under a high deductible health plan, described as one with a minimum annual deductible of $1,300 (self-only coverage) or $2,600 (family coverage)
- Not be covered by any other health coverage (exceptions exist)
- Not be enrolled in Medicare
- Not be claimed as a dependent on someone else’s tax return
Those who meet the eligibility requirements might be able to contribute up to the maximum annual limit for 2017 of $3,400 for self-only coverage or $6,750 for family coverage. There is a $1,000 catch-up provision if you are age 55 or older.
Healthcare costs make up a large portion of pre- and post-retirement spending and increase at a greater rate than most other expenses (read our previous blog post on retirement savings). Grubman Wealth Management suggests that individuals with a high-deductible health plan consider contributing to a Health Savings Account to help offset the costs of healthcare now and in retirement. Furthermore, if by some miracle your healthcare costs after age 65 are less than you expected, an HSA then essentially becomes an IRA.
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