Health Savings Accounts (HSAs) provide a way to save for medical expenses when your health insurance is a high deductible plan. Money you save into a Health Savings Account is pre-tax, meaning you won’t pay taxes on the amount you put into it, and when the funds are used for qualified medical expenses, you won’t pay taxes on what you take out. If you have the ability to invest the money, it also grows tax free. It is the only type of account that provides triple tax savings, and it is worth exploring how to incorporate it into your overall financial plan. Here are five things to keep in mind if you have an HSA.
1. Long-Term Savings
Health Savings Accounts are designed to save for medical expenses, but that doesn’t mean you have to use the money every time you see the doctor. If you pay your medical expenses out of pocket (like a health insurance deductible) instead of withdrawing money from your HSA, you can always take that same amount out of the HSA at any time in the future as a reimbursement to yourself so long as you’ve tracked the medical expenses along the way. Say you paid for $20,000 of medical expenses out of pocket over the last 10 years (and you can prove it), you can take a distribution of $20,000 from your HSA in year 11, and it’s all tax-free. It can become a valuable tax-free source of funds in retirement if you refrain from using along the way. Before implementing this strategy, we recommend verifying if your HSA plan allows you to invest money. If the plan does not allow for this, it might be more advantageous for you to pay for medical expenses from this account as you incur them so you can save your excess cash flow elsewhere to allow opportunity for your savings to grow.
2. Wealth Transfer
If your adult child is covered under your health insurance plan (children can stay on your health plan until age 26) and does not qualify as a tax dependent, he or she can open an individual HSA and you can contribute to it as a gift. Unlike a Roth or Traditional IRA, your child does not need to have earned income to be eligible for HSA contributions. Once your child is no longer covered under your health plan, he or she can keep the HSA for future medical expenses or as a long-term savings tool for retirement.
3. Legacy Planning
When you name your spouse as beneficiary of an HSA, he or she will inherit the HSA and can use it as their own. But be careful naming children or someone who is not your spouse as beneficiaries, as the entire account must be distributed in the year of your death, and it is a taxable event to your children. If your children are in a higher tax bracket than you are, it may make sense to name your estate as the beneficiary so that it flows through to your final tax return at lower rates.
4. Qualified HSA Funding Distribution (QHFD)
Current tax law allows for a once-in-a-lifetime rollover from an IRA to an HSA, providing an opportunity to access funds without paying any tax that would otherwise be taxed as ordinary income. The amount you can rollover cannot exceed what you would be eligible to contribute to an HSA in a year, but this strategy could be useful if you know you’re facing a larger qualified medical expense and could tap your IRA without paying the tax.
5. Catch-Up HSA Contribution
Similar to other retirement accounts, once you reach age 55 or older and before you enroll in Medicare, you are able to make an additional contribution to your HSA called a catch-up contribution. Eligibility for the catch-up contribution follows the HSA account holder. For married couples, it might make sense for each spouse to have their own HSA. You would be required to split the family maximum contribution amount of $7,000 between both HSA accounts, but then each spouse would be eligible to make the $1,000 catch-up contribution that year. This allows opportunity for the family to save an additional $1,000 to their HSA accounts.
As always, your personal goals and objectives will determine how best to incorporate a Health Savings Account into your overall financial plan, but they’re more than simply pass-through accounts for today’s medical expenses. If the balance in your HSA account grows to a size where your medical expenses will never exceed the balance, you can always take a distribution from the HSA account in retirement and it will be taxed similar to a Traditional IRA (as ordinary income). It is important to note that a distribution from an HSA account prior to age 65 used for non-qualified medical expenses will be subject to a 20% early withdrawal penalty. Using them strategically to meet your long-term goals can provide flexibility and more tax savings in the future.
JNBA is not an accountant and no portion of the above should be construed as accounting advice. All accounting issues should be addressed with an accounting professional of your choosing.
Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from JNBA Financial Advisors, Inc.
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