What is a Health Savings Account (HSA)?
Health Savings Accounts (HSAs) were created back in 2003 by the Medicare Modernization Act. This law created HSAs to encourage individuals to enroll in High-Deductible Health Plans (HDHPs) in an effort to curb overall healthcare spending.
HSAs offer several benefits and are probably best known for offering tax-free growth if used for qualifying medical expenses. However, they actually offer a few other tax advantage benefits.
- The opportunity for tax-deductible contributions, which saves on taxes today
- Tax-deferred growth on funds within the HSA account
- The potential for tax-free distributions for qualified medical expenses
Off all the tax-favored accounts the HSA arguably offers the best cumulative tax benefits. It should be noted, if one withdraws from the account, for reasons other than a qualified medical expense, before the age of 65 the withdrawal amount is taxable and subject to a 20% penalty.
Who can contribute to an HSA?
In order to contribute to an HSA, an individual must be covered by a qualifying High-Deductible Health Plan. It should be noted that not all HDHPs meet the requirements for an individual to open an HSA. For individuals who would like to have an HSA account, it would be prudent to carefully choose the right HDHP or ask their employer or CPA if their plan meets the requirements.
In addition to being covered by an HDHP, to quality to make an HSA contribution, an individual must also meet the following:
- Not be enrolled in any other non-HSA-eligible plan, including Medicare and Tricare
- Not be claimed as a dependent on someone else’s tax return
- Not be enrolled in a Healthcare Flexible Spending Account (FSA), other than a Limited-Purpose FSA or a Post-Deductible FSA
- Not be enrolled in s Health Reimbursement Account (HRA), other than a Limited-Purpose HRA, a Suspended HRA, a Post-Deductible HRA, a Retirement HRA, or certain Qualified Small Employer HRAs
What amount can be contributed to an HSA?
HSAs are subject to annual contribution limits. For persons with HSA-eligible self-only HDHP coverage for all of 2020, the maximum contribution is $3,550. An HSA-eligible family HDHP plan allows for a $7,100 annual contribution for 2020. If you are above the age of 55 then you are eligible for a $1,000 catch-up contribution.
A distinction that should be made is that HSAs are individual accounts, they are not joint HSAs. HSA accounts themselves are specific to the individual, but an HDHP plan that is HSA-eligible can render multiple individuals covered under the same HDHP plan, HSA-eligible. What this means is that if spouses are covered under a family HDHP plan that is HSA-eligible, both spouses can have an HSA account. However, they are still limited to the family contribution limits of $7,100 per 2020.
There are rules that govern HSA contribution limits, we recommend you work with an advisor to determine what the limits are depending on the type of HDHP plan. For example, spouses covered by separate self-only HDHP plans, each can contribute to the maximum, self-only limit to their respective HSAs, but they can not make up for any contribution shortfalls of the other spouse. Navigating these rules can help to avoid the 6% excess contribution penalty.
How to use an HSA account to its maximum benefit?
There are a few different ways to use your HSA. The first would be to use the account for qualified medical expenses. Or, if you are older than 65, an HSA can be used as an IRA alternative.
Qualified Medical Expenses
If you use the account for medical expenses you truly do get the trifecta of tax benefits. The money you contribute to the HSA is tax-deductible, it grows tax-deferred, and the withdrawals are tax-free. The goal is to contribute every year you are eligible and allow the funds in the account to compound and grow. The benefit of the HSA is not fully realized if you empty the account every year.
IRA Alternative
If you are lucky and healthy enough to not have to use your HSA throughout your lifetime, and you still have a balance at age 65, you receive some added benefits. Once you reach the age of 65 the 20% penalty on withdrawals not used for qualifying medical expenses goes away. This means you are eligible to take withdrawals from the HSA and that are only taxable, very similar to a Traditional IRA. The difference is that an HSA is not subject to Required Minimum Distributions as an IRA is. You can still keep the HSA until a medical expense arises, which would be tax-free, or to pass to the HSA beneficiary.
We recommend working with an advisor to determine the best contribution strategy when adding to an HSA. Depending on the period of life a family is in, there are more benefits to adding either to the older or younger spouse’s HSA.
What happens to an HSA when the account owner dies?
If the beneficiary listed on the HSA is the spouse of the original HSA owner, the spouse can simply take the HSA as their own. This means the HSA will still have the same tax treatment but be in the name of the surviving spouse.
If the beneficiary listed is anyone other than the spouse of the original HSA owner, the HSA account ceases to be treated as an HSA as of the date of the owner’s death. Any remaining funds in the account are treated as distributed to the beneficiary on the date of death and are taxable to the beneficiary in the year of the original owner’s death.
If the beneficiary is the original owner’s estate, the remaining value of the HSA will be included in the decedent’s income in the year of death.
Final Thoughts
Managing health care costs is an important part of any long term plan. By maximizing contributions to HSA accounts and making sure those contributions are made correctly and in the best possible manner. One can truly take advantage of the triple tax benefit. HSAs can benefit those in their high-income years just as much as those in retirement. They are a viable option in any plan and should not be overlooked.
HSA Planning When Both Spouses Have A High-Deductible Health Plan (HDHP)