“You can’t take advantage of an opportunity unless you know it exists!”
Paying more for medical expenses today is common. But are you paying in a tax-advantaged way? So, there’s an opportunity you should be aware of…the Health Savings Account (HSA). This little gem of a savings account allows you to save for qualified medical expenses pre-tax for both today’s and tomorrow’s medical expenses.
But first, let’s review the FSA which is often confused with the HSA.
The Flexible Spending Account (FSA) allows you to save for medical expenses today, meaning within the year you save. Importantly, if you’ve had an FSA account, there has been a slight rule change. It used to be that you must “use it or lose it” within the year saved. However, the U.S. Treasury Department and the IRS altered this long standing rule. The rule change now allows employers to offer a carryover of up to $550 in unused health FSA funds to the following year. Or, there’s a grace period option giving you a two-and-a-half-month extension to spend remaining FSA funds. But employers are not obligated to offer either option. So, make sure to check with your employer on their rules.
Here’s a quick note on the major differences between HSA and FSA:
HSA – Pre-tax savings -you can carry-over your balance into the next and future years. “Shoebox” the receipts for your qualified medical expenses. And “pay yourself back” for those qualified expenses from your HSA at any time.
FSA -Pre-tax savings -you typically cannot carry-over your balance into the next or future years. But, some health FSA accounts, depending upon the employer, allow a limited carryover of $550 to the following year. Or, a grace period option giving employees a two-and-a-half-month extension to spend remaining FSA funds. But, FSAs cannot have both a carryover and a grace period option.
High-Deductible Plans and HSAs
HSAs are often used with High-deductible Health Plans (HDHPs). HDHPs in effect, force you to be more cost conscious when deciding on medical care. And, the HDHP places more of the responsibility and cost burden on consumers. Yet, like traditional health care plans, HDHPs usually cover a wide range of medical and prescription costs. But remember, there’s that steep annual healthcare deductible.
An HSA can help offset the higher out-of-pocket costs you have with an HDHP. Contributions to an HSA are not taxed when you use the funds for qualified medical expenses. And, as an employee your contributions are pre-tax. Additionally, employers sometimes contribute to this type of savings on your behalf as well. Importantly, your contribution and any contribution made by your employer on your behalf are tax-free.
HSAs and Employee Eligibility
You are eligible for an HSA if you meet four qualifying criteria:
- enrolled in a qualified HDHP
- not covered by another disqualifying health plan (whether insurance or an uninsured health plan)
- not eligible for Medicare benefits
- you’re not a dependent of another person for tax purposes
Tax Advantages of the HSA
Pretax contributions: You can make contributions to your HSA with pretax dollars.
Tax-free gains: Any gains on the money in your HSA are tax-free when the funds are used for qualified medical expenses. So, you keep 100% of any money your HSA savings or investments earn.
Tax-free withdrawals: For qualified medical expenses, you won’t pay taxes on money you withdraw.
How do I know what qualified medical expenses are?
The IRS has publications that detail the HSA and these expenses within the IRS Publication 502 and 969. You can also find examples of qualified medical expenses at https://healthsavings.com/hsa/what-is-covered-by-an-hsa/.
How is an HSA like a “shadow 401(k)”?
- Tax Deductible Savings: You can save and invest pretax dollars in an HSA account and get a tax-deduction for the dollars you save.
- Long-term Savings & Investment Options: Your excess dollars, meaning those you do not spend on qualified medical expenses, can accumulate for many years. And as you save, the HSA often has options for investing the funds you may not need today, typically in a savings account or mutual fund choices.
We see one of the amazing benefits of the HSA as the potential to invest for the long-term in a tax-advantaged way.
With an HSA, funds are available anytime, tax and penalty free for qualified medical expenses. But, a 20% penalty tax applies if you’re under age 65 and use the funds for nonqualified medical expenses. An exception to this rule is if you are totally and permanently disabled. But, after age 65, there’s no penalty tax. However, ordinary income taxes apply on withdrawals for any reason other than for qualified medical expenses. Yet, qualified medical expenses remain tax free. So this account becomes like a “shadow 401k” at age 65. That’s when you can remove the funds for any reason without penalty. Yet, like a 401k, you may pay tax on your withdrawal if not used for qualified medical expenses.
What is the maximum amount I can contribute to an HSA account in any year?
While contribution limits may change from year to year, in 2020, the maximum contribution for individuals is $3,550 and for a family it is $7,100. However, if you are age 55 or older, there is a “catch-up” provision allowing for an additional $1,000 contribution or $4,550 for individuals and $8,100 for families.
For 2021, the maximum contribution for individuals will be $3,600 and for a family $7,200. And, if you are age 55 or older, there is that “catch-up” provision allowing for an additional $1,000 contribution. (SHRM.org)
If you don’t yet have an HSA account through your employer, it is possible to open one on your own if your current health insurance meets the criteria as a HDHP. And your human resources department is the best place to find out if your current health insurance plan qualifies as a HDHP.
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