Changes in the health care marketplace, rising medical costs, and the tax advantages that health care savings accounts (HSAs) offer make them an attractive planning tool for many individuals covered by high-deductible health plans (HDHPs). I have had some questions from clients recently regarding HSAs and what they entail, so I thought it would be helpful to outline some Frequently Asked Questions, below:
An HSA is a tax-advantaged account that can be used to pay for specific qualified medical expenses. Unlike with flexible spending accounts (FSAs), which are designed to cover current out-of-pocket medical costs, the money in HSAs never expires and can be used to pay for health care expenses now and in retirement. HSAs may be offered through your employer or purchased directly if you are eligible. They can be established at a bank, insurance company, or IRS-recognized third-party administrator.
Generally, contributions to an HSA are tax deductible. Their earnings accumulate tax deferred, and withdrawals are tax free if used to pay for qualified expenses. If, before you turn 65, you withdraw funds from an HSA that are not used for qualified medical expenses, the withdrawal will be subject to a 20-percent penalty, in addition to income tax. After age 65, distributions not used for qualified medical expenses are no longer subject to the 20-percent penalty.
To establish an HSA, you must be covered by an eligible HDHP. For 2019, this is defined as a plan for which the family annual deductible minimum is at least $2,700 ($1,350 for an individual), and the annual out-of-pocket costs are limited to $13,500 for family coverage ($6,750 for an individual). Your health care benefit provider can confirm whether your plan is considered an HDHP that is eligible for an HSA.
You are generally not eligible to contribute to an HSA if:
In 2019, the HSA contribution limits are $7,000 for a family account and $3,500 for an individual account. If you are 55 or older, you may make an additional catch-up contribution of $1,000 per tax year. You can contribute to an HSA for the current tax year any time prior to the tax filing date of April 15.
Contributions to an HSA may be made by you, another individual, or your employer. Employer contributions made on your behalf through a cafeteria plan are generally not income taxable to you. If you contribute directly to an HSA, the contributions are considered “above-the-line” deductions, which means that you can claim them without itemizing deductions on your tax return. Your tax advisor can provide more information on the tax treatment and deductibility of HSA contributions.
You can make tax-free withdrawals from an HSA for qualified medical expenses for you, your spouse, or other dependents. Eligible expenses include lab fees, prescription drugs, and dental and vision care, as well as out-of-pocket health insurance deductible costs.
You may also use distributions to pay for certain insurance coverage, including:
(Qualified medical expenses are detailed in IRS Publication 502.)
Both spouses can contribute to an HSA if they are covered separately under eligible HDHPs.
You are permitted to take a qualified HSA funding distribution from your traditional IRA or Roth IRA into an HSA once in a lifetime. This must be a trustee-to-trustee transfer. The amount is limited to your maximum HSA contribution for the year minus any contributions you have made for the year. (Distributions are not allowed for SEP IRAs or SIMPLE IRAs.) A benefit of doing this is that there are no required minimum distributions beginning at age 70½ from an HSA. Plus, withdrawals can be taken income tax free when used for qualified medical expenses.
Because there are no restrictions on when you need to distribute HSA funds, you may wish to pay out-of-pocket health care costs from your current income and allow the HSA to continue to grow tax deferred, reserving those funds to cover medical care in retirement.
HSAs offer several other advantages, including the ability to take the HSA with you if you leave your employer. You can also name a beneficiary to inherit the HSA in the event of your death. It’s important to note that your spouse can step into your role upon your death and the account will remain an HSA. If you name a nonspouse beneficiary, however, the account will no longer be considered an HSA, and the inherited amount will be treated as taxable income.
As a guest blogger, I'm unable to respond directly to comments posted below, but if you have any questions about qualified and non-qualified expenses, please feel free to contact me directly - I'm happy to help! Additional information on HSAs is also available in IRS Publication 969.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
Kristen Smith is a guest blogger, representing Axial Financial Group in Burlington, MA. She offers securities as a Registered Representative of Commonwealth Financial Network, Member FINRA/SIPC. CRR, LLP (also represented as CRR, CRR CPA), Axial Financial Group, and Commonwealth Financial Network are separate and unrelated entities. Kristen can be reached at 781-273-1400 or ksmith@axialfg.com. This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend that you consult a tax preparer, professional tax advisor, or lawyer.