Let Me Clarify

Building on the topic of health insurance, I want to spend some time specifically on Health Savings Accounts; commonly referred to as “HSA’s”. As most insurance plans are moving in the direction of “high deductible plans” (refer to previous blog on Health and Wealth, if you have not already), these accounts are extremely important, not only to the medical coverage itself, but also to the numerous planning opportunities they provide.

Let me clarify.

From tax benefits and employer funding to medical uses and investment opportunities, in my opinion, HSA’s are perhaps one of the most beneficial accounts consumers have access to. Be aware there are a variety of rules and restrictions that surround these accounts, so let’s walk through the basics that you should know.

HSA’s are only available if you are on a High Deductible Health Plan. At the expense of having a lower premium and meeting the IRS’s definition of having a “high deductible”, Health Savings Accounts are made available to help offset paying for higher out-of-pocket costs. Money that is contributed to these accounts can be paid directly to medical providers, reimbursed to yourself for any qualified medical expenses that you pay for out-of-pocket, or even rolled over from year to year and invested.

HSA’s are perhaps the most tax-advantaged account out there.

1. Contributions are pre-tax (considered a tax deduction or reduce the amount of income subject to tax in that year)
2. Any earnings grow tax deferred (no taxes are paid on growth throughout the year)
3. As long as the money is used for “Qualified Medical Expenses” (per IRS Publication 502 ) distributions come out of the account tax-free as well

Contributions are subject to an annual limit. As you might expect, especially with the numerous tax benefits, there is a limit to how much you can contribute to an HSA each year. For 2020, an individual can contribute up to $3,550, and a family can contribute up to $7,100. Those who are age 55 or older are also allowed an additional $1,000 catch-up contribution. Be aware that any contributions to these plans that are made by your employer count toward the annual limits.

For example, if your employer contributes $500 to your plan in January, an individual or family can only contribute $3,050 and $6,600 respectively for 2020, excluding catch-up contributions.

Note: individuals covered by anything that is not considered to be “high deductible coverage” are ineligible to open or contribute to these accounts and would be subject to tax penalties. It is extremely important to consult with an insurance professional or advisor regarding your specific eligibility.

Certain balances can be invested. As mentioned, HSA accounts are not “use it or lose it” and funds are rolled over from year to year. Most administrators allow you to invest these funds once your balance reaches a certain level. Options could range from a limited list of investments (like what a 401(k) plan offers) to a much broader platform of options.

Personally, I typically recommend that clients leave at least their annual deductible amount in cash in case these funds are needed for an emergency, before investing the rest. However, your specific cash flow situation and other goals may create a variety of other planning opportunities that could impact how to manage the account.

Distribution rules change at age 65. Pre-65, distributions must be used to cover “qualified medical expenses” to qualify as tax-free. Otherwise, non-qualified distributions are subject to income taxes and a 20% penalty. However, after age 65, the 20% penalty no longer applies. This means any non-qualified distributions are then taxed as ordinary income, like the tax treatment on withdrawals from an IRA. Of course, you will still want to take out as much as you can tax-free, but this eases the concern of “overfunding” the account and hurting yourself taxwise.

Again, there are more rules and other nuances surrounding Health Savings Accounts than I can cover in a short blog. For instance, having an FSA (Flexible Spending Account), changing medical plans mid-year, rollover options, and contributing directly versus payroll deduction, are just a few of the situations that can throw a wrench in the broad explanations above.

While I think those who have access to HSA’s should maximize the opportunities made available, I have seen a lot of mistakes made and cannot stress enough the importance of working with a professional if you have any questions or are just getting started.

I encourage you to submit any ideas, topics, or questions to info@clarifywealth.com. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. “Let Me Clarify” is a weekly blog containing Chad Baxter’s insights and thoughts about a variety of topics. To learn more about Chad,click here