HSA Plans – What You Need To Know

HSA Plans - What You Need To Know

HSA Plans – What You Need To Know

HSA plans, short for Health Savings Account, should not be ignored. These were created in 2003 to provide special tax treatment for those with high-deductible health insurance plans. However, not everyone is eligible for a Health Savings Account. If you are, you should really give it a solid look.

According to the HealthCare.gov site, “the IRS defines a high deductible health plan as any plan with a deductible of at least $1,400 for an individual or $2,800 for a family. An HDHP’s total yearly out-of-pocket expenses (including deductibles, co-payments, and coinsurance) can’t be more than $6,900 for an individual or $13,800 for a family.” This type of plan usually requires more out of pocket costs than traditional plans.

HSA Plan And Eligibility

  1.  You need to be covered by a high-deductible health plan (HDHP). If you're not sure, contact the insurer to find out.
  2.  You can't have other health insurance coverage. This does not apply to insurance like disability, dental, vision, or long-term care.
  3.  You can't be enrolled in Medicare.
  4.  You can't be claimed as a dependent by anyone else.

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HSA Plan Benefits

Tax benefits like no other: These accounts provide a powerful incentive for use due to unique tax benefits. Contributions made to an HSA are tax deductible. If an employer makes contributions on your behalf, those contributions are excluded from your taxable income. If you make the contributions, they are a deduction. Interest and other earnings on your investment are tax exempt. As a result, no 1099s at the end of the year are needed like a traditional investment account. Lastly, withdrawals made to cover qualified healthcare expenses can be made tax free!

Unused balances can be spent in future years: There is no “use it or lose it” feature with HSAs. Other healthcare related accounts can require that all balances be spent by the end of the year. If you don't, that money disappears. This isn't the case with HSAs. Therefore, account balances are carried over for use in the future whether it be next year, in ten years, or beyond.

There is no income limitation: Some taxpayers are excluded from participating in certain tax advantaged accounts. For example, Roth IRAs offer the attractive option of funds that can used tax free in retirement. However, this is only an option for those with modified adjusted gross income (MAGI) under $139,000 for single filers and $206,00 for married filers (2020). Individuals and couples who couldn't qualify for a Roth IRA based on income, might be eligible for the tax free benefits of an HSA.

Health Savings Account Taxation

IRAs, Traditional 401(k), and 403(b) allow for tax deductible contributions which reduce current year tax liability. While investment earnings aren't taxed, the future withdrawals of principal and earnings are. This method of taxation often catches a lot of people by surprise upon retirement. Think about replacing your annual income with withdrawals that are fully taxable as ordinary income. Most people are shocked by the amount of taxes owed each year. Consider a $10,000 distribution and while being in the 20% bracket. That means you end up netting $8,000. The other $2,000 evaporates into thin air!

Roth IRAs and Roth 401(k) do not allow for a tax deduction. Contributions are known as “after tax” so they do not reduce current tax liability. Investment earnings and future withdrawals are not taxed. This is why Roth IRAs are often referred to as “tax free” retirement accounts. I suggest taking a look at another article I wrote called Tax-Deferred vs Tax-Free Investment Accounts for more detail on this.

HSA Plans allow for a tax deductible contribution that reduces current tax liability. In addition, the investment earnings and future withdrawals are tax free. This is like getting the best of both worlds. You get the tax deduction of an IRA and tax free withdrawals of a Roth IRA.

Health Savings Account - Tax Comparison

Health Savings Account – Tax Comparison

Health Savings Account Contribution Limits

Contributions, for those with individual coverage, are limited to $3,550 ($4,550 for those 55 or older) in 2020. Those with family coverage can contribute up to $7,100 ($8,100 for those 55 or older). It is important to remember that these limits apply to employer and employee contributions combined. Therefore, you should be careful not to over fund the account. On the other hand, this is less of a concern if no employer contributions are involved.

Another consideration is that you can make contributions up until you file your taxes. This is similar to the way IRAs and Roth IRAs are funded. For example, as long as you are eligible to make a contribution to an HSA, you can fund the account by April 15 (or whichever day tax day falls on that year) for the prior tax year. While this created flexibility on one hand, it can create confusion on the other.

Make sure you know what year your contribution is funding. Many people have recurring monthly contributions so you need to be careful that you don't inadvertently over fund the HSA. For example, consider that you have $200 per month on auto deposit in January through April. If those deposits are coded as “prior year contributions,” and you already maxed out your contribution limit by December, you run the risk of over funding.

IRA Rollovers To HSA Plans

If you are eligible to participate in an HSA plan, you are allowed to rollover from an IRA. A common attribute of rollover transactions is the ability to do so tax and penalty free. One key distinction with rolling IRA funds to an HSA is that you can only do it once. In addition, you can only rollover up to the maximum contribution for that year.

Despite this, rolling funds from and IRA into an HSA might still be a wise financial move. As mentioned earlier, IRAs will ultimately be taxed when you withdraw in the future. HSA plans, on the other hand, allow tax free withdrawals. Consider the following scenario.

A 45 year old (filing jointly) rolls over $7,100 from an IRA into a Health Savings Account. If those funds aren't spent on out of pocket medical expenses, over the next 20 years, it could reasonably grow to $18,838 (assuming 5% return). Now, at age 65, withdrawals can be made tax free. Stated another way, it could save $3,767 in taxes (assuming 20% tax rate).

In conclusion, HSA plans are powerful financial planning tools. With the ability to allow account balances to rollover to future years and its unmatched tax benefits, Health Savings Accounts should not to be ignored.

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3 Responses to HSA Plans – What You Need To Know

  1. Lee @ BaldThoughts November 23, 2016 at 10:03 am #

    After ignoring HSAs for a few years, I finally took the plunge last year after calculating that my insurance cost would effectively be the same as the normal PPO + FSA strategy that I was using before. Now, I’m not “looking” for medical expenses to pay at the end of the year so that I use up my FSA before the deadline… instead, I’m happy to let the balance roll over and accrue investment returns year after year!

    • David Waldrop, CFP® November 23, 2016 at 10:12 am #

      Thanks Lee for your comment and sharing your experience. For a lot of people, it’s just one more thing to keep track of and get your arms around. Between company retirement accounts, personal investments, college savings plans etc., I can see how this can lead to “account fatigue.” I would be curious to know how many people with a high-deductible health plan (HDHP) DON’T utilize an HSA. I have a feeling that many people who could really benefit from an HSA are missing out.

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