Health Savings Accounts

By Glenn J. Downing, MBA, CFP®

What is the best tax bargain out there? 

Is it the 529 college savings plan?  Let’s see.  That is funding with after tax dollars, but the funds grow without taxation and come out without taxation when used for qualified higher education expenses.  That’s a double tax advantage.

How about the Roth IRA?  Same thing as the 529.  A double tax advantage. 

How about a Traditional IRA?  Here I deduct on the way in and have growth without taxation.  The tax bill comes when I distribute.  So this is another double tax advantage. 

Is there a triple tax advantage out there?

Yes!  There is one to my knowledge, and that is the Health Savings Account. 

The HSA is used in conjunction with a high deductible health insurance plan (HDHP).  This is one which, per IRS regulations, has a deductible of at least $1400 for an individual or twice that for family coverage.   We’re increasingly seeing HDHPs as employer offerings.  As health insurance premiums have soared, many employers have transitioned to this type of plan to cut costs.  On the upper end, the maximum out-of-pocket expense in a HDHP for an individual is $6900 in network for an individual and $13,800 for a family. 

The risk for the insured is that there is potentially large out-of-pocket expense each year.  Consequently the HDHP is offered in conjunction with a Health Savings Account, which is meant to be a place to accumulate that annual deductible and save into future medical expenses. 

Contribution limits

An individual can contribute $3550/year into an HSA (2020).  The number is double for a family.  In addition, if over age 55, an additional catch-up contribution is available.  Many employers contribute to the employee’s HSA.  In this way the insured can accumulate funds during the working years which will most likely be used in the wintertime of life. 

Once you are covered by Medicare, no further HSA contributions are allowed. 

I can’t imagine who would do this, but an HSA may receive contributions from an eligible individual or any other person.  Sort of like crowdfunding.  Contributions, other than employer contributions are deductible on the eligible individual’s return whether or not the individual itemizes deductions.

This is important to understand.  Currently medical expenses (and insurance premiums) are deductible only if they exceed 7.5% of AGI on Schedule A, Itemized Deductions.  But this 7.5% limit does not apply to the HSA.  It is deducted directly on Line 12 of the 1040 Schedule One. 

This is Not a Healthcare FSA

Please don’t confuse the health savings account with the healthcare flexible spending account.  The latter is part of a cafeteria plan and has the use it or lose it feature – meaning balances exceeding $500.00 cannot be carried forward into the next year.  With the HSA, the account balance is your asset, shown on your personal balance sheet.  There is no risk to you losing it, other than by poor investment choices.  If you die with a balance, the balance is now owned by your named beneficiary.

Non-Taxable Withdrawals

You can withdraw funds from your HSA for:

• Retiree medical insurance premiums, including Medicare supplements and long-term care policies
• Prescription drugs
• Hearing aids and eyeglasses and contact lenses
• Other medial expenses not covered by your HDHP policy.

Remember – this is the triple tax advantage!  When withdrawn for qualified medical expenses, these funds are tax-free.  You can sort of conceive of these funds as a back-up retirement account, since medical expenses are not a matter of whether they’ll occur, but rather of when. 

What Happens When I Die?

If your spouse is the beneficiary, that spouse can continue to use the HSA just as you did, and with the same tax advantages.  The spouse does not need to have a high deductible health plan in this case. 

If you leave the funds to a non-spouse beneficiary, then the account becomes taxable to that beneficiary in the year of your death.  Sort of like inheriting an annuity:  a tax hit to be sure, but sort of a high-class problem.  You’ll still come out ahead. 

Over Age 65?

Withdrawals over age 65 for any purpose are simply taxable as ordinary income.  Meaning your HSA will work like an IRA.  But withdrawals for the qualified medical expenses are fully tax-free.  

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