Are Health Savings Accounts (HSA) the Ultimate Health Care Insurance Plan?

Byron T. Deese Personal Finance, Tax Planning For Individuals Leave a Comment

Health Savings Account HSA

The Health Savings Account (HSA) has been around for more than 15 years, yet it remains one of the best-kept secrets as a tax savings and medical expense reduction tool. With health care costs on the rise and the health care insurance industry in a state of flux, HSAs are once again emerging as an attractive alternative, especially for people who are generally in good health and who want more control over their health care expenses. Anyone can benefit from the substantial tax benefits available with HSAs if they know how to optimize them.

Employers are increasingly turning to HSAs as a way to lower costs while empowering their employees in the health care marketplace. With HSAs, employees can pay less for health care by shopping and comparing providers, which can further stretch their HSA funds. Employer contributions are not taxable to employees.

What Exactly is a Health Saving Account (HSA)?

An HSA is similar to an Individual Retirement Account (IRA) in that it allows for pre-tax contributions that can grow tax-deferred. When used to pay for eligible medical expenses, the withdrawals are tax-free. That’s a tax-favored trifecta.

HSA Contributions

HSA contributions must be made in cash, and employees can elect to have their contributions direct deposited into their HSAs. Individuals establishing their own HSA can claim their contributions as an above-the-line deduction, which is a significant advantage considering increased standard deductions coupled with the 10% threshold requirement for deducting medical expenses on Form Schedule A.

For 2020, the HSA contribution limit is $3,550 for individuals and $7,100 for families, regardless of income level. A catch-up provision allows individuals over 55 to contribute an extra $1,000. Individual and employer contributions for the 2020 tax year can be made through April 15, 2021. Under the “last-month rule,” individuals are considered eligible for the entire year if an HSA is established no later than the first day of the last month of the tax year (December 1 for most taxpayers).

HSA Eligibility

To be eligible for an HSA, individuals cannot be covered by another health plan (except for disability, vision, dental, and long-term care plans), including Medicare. They also can’t be claimed as a dependent on another person’s tax return.

As a co-requisite for establishing an HSA, individuals must be covered by a High-Deductible Health Plan (HDHP). An HDHP HSA higher annual deductibles than traditional health plans, but they also have lower premiums. The idea is to have an HDHP plan cover major medical costs while the HSA covers minor costs, such as doctor visits and preventative care. For 2020, the IRS HSA set a minimum deductible limit for HDHP plans as $1,400 for individuals and $2,800 for families. The maximum out-of-pocket expenses to be paid in 2020 (including deductibles, copayments, and coinsurance) cannot exceed $6,900 for individuals and $13,800 for families.

HSA funds may still be withdrawn tax-free to cover eligible medical expenses even if the account holder drops the HDHP coverage, but no additional contributions are allowed.

Lifetime Planning

Unlike other medical savings accounts, there is no “use it or lose it” requirement with HSAs. In addition, HSAs are portable, allowing employees to move them to another employer or maintain them individually as long as they meet eligibility requirements.

Any funds remaining in an HSA at the end of the year can be rolled into the next year all the way into retirement. At age 65, individuals may withdraw funds to cover any expense without penalty, but they will be taxed as ordinary income.

Summary of HSA Tax Benefits

  • Tax-deductible contributions. HSA contributions qualify for an above-the-line deduction
  • Pre-tax employer contributions. Employer contributions are excluded from employees’ gross income.
  • Tax-deferred earnings. HSA earnings accumulate tax-deferred.
  • Tax-free withdrawals. Withdrawals used to cover eligible medical expenses are not taxed. However, if used to pay for ineligible expenses, they are taxed as ordinary income and subject to a 20% penalty tax.

HSA Planning Opportunities

In addition to the substantial tax benefits, the flexibility of HSAs creates numerous planning opportunities, especially in retirement. The ability to roll unused funds year-to-year into retirement can add substantially to a retiree’s available capital. This can be especially beneficial at a time when medical spending is at its highest.

 From a planning standpoint, there are many twists and turns in the tax code that need to be understood as it relates to eligibility, deductibility, and its applicability in different situations. As with any health plan, there is no one-size-fits-all solution, so it would be essential to work with your financial advisor to determine if an HSA would be the best fit financially for your health care needs.

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Byron T. Deese

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