By Steve Tepper, CFP®, MBA
I remember back about a decade ago when health savings accounts were a thing. Then they weren’t a thing. Now they are a thing again. If you are maxing out your tax-deductible savings in other accounts [IRA, 401(k), etc.] or if your out-of-pocket medical expenses are taking a bite out of your budget, ask your financial advisor if an HSA might be right for you.
OK, I promise from here on I won’t sound like a commercial for arthritis medicine.
As a primer, an HSA allows an individual or a family to make pre-tax or tax-deductible contributions to an account, like an IRA, and make tax-free withdrawals from that account to pay qualified medical expenses, provided you have medical insurance classified as a “high deductible” plan.
I first learned about these accounts more than a decade ago when our business selected a high-deductible medical plan for our employees. Don’t hold me to this, but I’m pretty sure the deductible for the plan that year was at least $5,000 for family coverage. That meant each employee had to pay a lot of money out of pocket before insurance started to cover costs.
By opening an HSA, we still had to pay those dollars to meet the deductible, but they ended up being pre-tax dollars. That can make a big difference, depending on your tax bracket.
A couple of years later, the company had a plan that no longer qualified as high deductible, so we were no longer able to contribute to the HSA. Eventually, I spent all the money in the account on various medical expenses and forgot about it.
A report last year from America’s Health Insurance Plans (AHIP) stated that over the last decade, HSAs have seen a 400% increase in popularity, with more than 21 million accounts by 2017. That caught my attention and sent me digging to find out why.
It appears to me that one of the major drivers of the surge in HSA accounts is a more lenient definition of a high-deductible plan. In 2019, the deductible can be as low as $1,300 for an individual or $2,600 for a family plan. If your plan meets that criteria, you can contribute up to $3,500 (single) or $7,000 (family) to an HSA, and an extra $1,000 if you are age 55 or older. Whatever you contribute over the year, up to those limits, can be deducted from income on your 2019 taxes. That deduction applies whether you take any money out of the account or not.
So that’s how money goes into the account. What about distributions? You can take money out to pay medical expenses for yourself, your spouse, and your dependents, even if they aren’t covered under your medical plan, and those withdrawals are not subject to tax. Pretty much anything health related could be a qualified expense, with a few exceptions:
Cosmetic surgery
Health club dues
Illegal treatment
Maternity clothes
Sundry items like toothpaste and toiletries
Medical plan premiums (unless you are receiving unemployment or on COBRA)
So bottom line, a lot more than just office visits, prescriptions and hospital bills can be paid with HSA dollars, including eyeglasses and contact lenses, braces, vasectomies, dentures, and many over-the-counter drugs like allergy medicines, pain relievers, cold medicine, and cough drops. If you have a debit card linked to the account, you can pay at the register and have the money come straight from the account.
The balance of your HSA grows tax-free. Like an IRA, you will have to pay taxes and a penalty on withdrawals (if they aren’t qualified medical expenses), unless you are age 65 or older or totally and permanently disabled. (Taxes still apply in those situations.)
When the main account holder dies, the balance of the account either will pass to their spouse and remain an HSA, or will cease to be an HSA and become part of the account holder’s taxable estate.
Remember, the HSA option is available even if you already have an IRA or other tax-deferred savings accounts. It can be a useful tool to increase retirement savings or reduce medical costs. Talk with your insurance provider or plan administrator to learn more.
Sources:
“HSAs Have Gotten 400% More Popular in The Last Decade. Insurers Say the Law Hasn’t Kept Up,” www.advisory.com, April 18, 2018.
“HSA Center Frequently Asked Questions,” www.hsacenter.com