The “Triple Threat” Savings Vehicle

Whenever a client tells us they are eligible for a Health Savings Account (HSA), we get excited. Why? Because anytime there is a tax-advantaged way for our clients to increase their savings, we are on board. When the tax benefits are threefold, it’s a hard deal to pass up.

What is an HSA? An HSA is a savings account specifically dedicated to medical expenses. This type of account is available to individuals who are enrolled in a qualified high-deductible health plan (HDHP), which is fairly common these days. The IRS defines a qualified HDHP is one in which the deductible is at least $1,400 for an individual or $2,800 for a family (2021 and 2022 tax years). The plans have maximum annual out-of-pocket expenses as well: $7,000 for an individual or $14,000 for a family in 2021 and $7,050 for an individual or $14,100 for a family in 2022.    

Triple Tax Benefit:

1. Contributions are pre-tax: You either receive a deduction on your tax return or via your paycheck if contributing through payroll, reducing your taxable income.
   
   
2. Funds can be invested: Earnings (dividends, interest, capital gains) grow tax-free.
   
   
3. Distributions for qualified expenses are tax-free: Withdrawals for qualified medical expenses are tax-free. This means the funds you contribute, invest, and later withdraw are never taxed! This makes HSAs more effective than using funds from IRAs or 401(k)s for medical expenses since distributions from these types of plans are taxed at ordinary income rates.

Note: HSAs are most effective when medical expenses can be paid for using outside funds, allowing HSA funds to remain invested and growing tax-free.

Additional Benefits/Features:

• There are no income-related caps to contribution eligibility
  
  
• There is no earned income requirement: contributions can be made even in years you may not have income
  
  
• HSA reimbursements are not required to be done in the same year as an expense is incurred (as long as you are not reimbursing yourself for an expense that pre-dates the HSA)
  
  
• HSAs are portable, meaning you can take yours with you if you leave your employer
  
  
• Unlike other health savings vehicles, HSAs are not “use-it-or-lose-it”; funds remain in the account until you want to access them and HSAs do not have required minimum distributions (RMDs)
  
  
• HSAs can be left to beneficiaries, which is a benefit over other medical savings plans if left to your spouse as the account will be treated as his/her HSA upon your death (no taxable event). The downside here is that for non-spouse beneficiaries the account ceases being an HSA at your death and the entire fair market value is taxable at once
  
  
• Age 65 unlocks even more benefits:
  • HSA funds can be used to pay for Medicare premiums, except supplemental policies like Medigap
  • Funds can be withdrawn for non-qualified expenses without the 20% penalty. Withdrawals are still subject to taxation, so effectively become like IRAs or 401(k) plans if used for non-medical expenses, but are not subject to RMD requirements

Contribution Limits (Employee + Employer):

 *Individuals over the age of 55 may make an additional $1,000 “catch-up” contribution (see pitfalls to avoid)

Deadline: Contributions for a given tax year must be made by the tax filing deadline. For the 2021 tax year, this deadline is April 18^th, 2022.

Common Pitfalls to Avoid:

• Overfunding: Contributions made in excess of the limits outlined previously are subject to a 6% excise tax if not removed before the tax deadline.
  
  
  • Special rules for married couples:
    • If both individuals are covered under one spouse’s plan, only the HSA owner may make the catch-up contribution, even if both spouses are over age 55
      
      
    • If either spouse has family HDHP coverage, both spouses are assumed to have family coverage. Even if each spouse has their own HSA-eligible HDHP, the combined $7,200 family limit applies (for 2021). However, in the case where each spouse has their own plan and are over the age of 55, both are eligible to make the $1,000 catch-up contribution
      
      
  • Continuing to contribute after a change in coverage: If you change health coverage to a low deductible or non-qualifying plan, you must stop making HSA contributions immediately
    
    
  • Taking distributions for non-qualified expenses: Not all health-related expenses are considered qualified by the IRS (such as cosmetic surgeries. Ensure distributions from your HSA, particularly before the age of 65, are for qualified medical expenses (see IRS publication 502 for more information: https://www.irs.gov/pub/irs-pdf/p502.pdf)
    
    
  • Using your HSA for ineligible individuals: Your HSA may only be used to pay for medical expenses for you, your spouse, and/or qualified dependents.
    
    
  • Spending the entire HSA balance each year: Remember, your HSA is not “use-it-or-lose-it” like a Flexible Spending Arrangement (FSA), so you are not required to deplete (or forgo) the balance on an annual basis. In fact, the benefits outlined in this article are amplified if you do not spend down the balance each year
    
    

If you’re not already taking advantage of the powerful savings opportunity of an HSA, and you have questions about how to set one up or how it fits into your plan, we are here to help.

Meghan Carson, CPA, CFP®
Financial Advisor

3/14/22