Rules for a Health Savings Account (HSA)

I remember the excitement of starting my career fresh out of school.  My employer went through all of our benefits, and briefly mentioned the high deductible health plan.  I should have paid more attention to the details of my health coverage.  The focus was on my salary, 401(k) match, and paid time off.  More attention would have been made If I knew about the tax advantages of an health savings account (HSA).  Additionally, my employer made a $500 annual contribution, which I assumed to be enough to cover my health care costs.

A Health Savings Account (HSA) is a diversified savings and investing tool that can be used for medical expenses. Personally, it is one of my favorite savings and investing tools.  An HSA is a health coverage that incorporates a high deductible health plan (HDHP) with a savings account that allows an individual to save money.  The money is deposited before taxes.  It can be used to cover qualified medical expenses. It is also known as a triple tax-savings vehicle.

The intent of this post is to for two things.  The first, is to share the IRS laws for contributing to an HSA,  The second, is to share my approach in handling an HSA and my contributions.

Next, I will discuss how my HSA has affected my annual taxes.

How Does an HSA Impact my Taxes?

Health Savings Accounts (HSA's) are known as a triple tax savings vehicle. The intelligent investors use this as a mechanism to lower their yearly tax expense, accumulate capital gains (tax free), and pay for qualified medical expenses without being taxed or penalized.  Next, I will discuss the three tax savings advantages in more detail.

The first, your annual tax bill is lowered.  If possible, I always attempt to max out my annual HSA contribution.  It has an astonishing benefit of lowering an individual's adjusted gross income (AGI).  In other words, my employer deposits my specified contribution amount into my account.  This occurs without a reduction from taxes. This "above the line" reduction lowers my AGI. Consequently, this decreases my annual tax bill.  I am always trying to reduce costs.  That includes the pesky Federal Insurance Contributions Act (FICA) expense.  Indeed, taxes are costs too.

The second, investment gains will be tax free.  Upon reaching a specified amount, a health savings account balance can be invested. The money can be placed into index funds or bonds. The invested assets can accumulate more wealth, which will not be taxed. Do not forget about the eighth wonder of world, compound interest!  For this reason, I maximize my HSA contributions.

Lastly, my investment gains can pay for qualified medical expenses, tax free.  Indeed, I do not pay taxes on funds that are withdrawn to pay for qualified medical expenses.  This will be beneficial in retirement.  Undoubtedly, health care needs will arise in older age.

Next, I will review who can qualify for an HSA.

Who Qualifies for an HSA?

According to the IRS, an individual can qualify for an HSA if they:

1.  Are covered under a high deductible health plan (HDHP), on the first day of the month.  The minimum annual deductible and maximum annual deductible and other out-of-pocket expenses for HDHPs are as followed:

   

2.  An individual has no other health coverage except for what is allowed by the IRS.
   • Generally speaking, someone who has a HDHP and a FSA or an HRA that reimburses qualified medical expenses cannot contribute to an HSA.  However, there are certain arrangements that are allowed.  Consulting financial planner can aid in understanding these arrangements.
3.   The individual is not enrolled in Medicare.
4.   You are not eligible if you are claimed as a dependent on someone else’s tax return.

What is the Maximum Annual Contribution to an HSA?

There are a couple of answers to this question.  First, you must remain an eligible participant of an HSA. Secondly, contribution amounts are dependent upon who your insurance covers.  The contribution amount for a single individual (in 2020) is $3,550.

If the insurance covers a family, than the contribution limit is $7,100 for 2020.  In my opinion, this is a substantial reduction in a family's adjusted gross income (AGI).  Subsequently, this reduces the burden of the annual tax liability.

An individual should reduce their HSA contribution if their employer also contributes to it. This is important to consider when automatically depositing from your paycheck each month.

Again, medicare recipients are not allowed to place contributions into their HSA's.  This commences on the first day, of the first month an individual is enrolled in it. This rule applies to periods of retroactive coverage (backdated coverage).  However, upon reaching 65 an individual can withdraw money out of their HSA for non-qualified medical expenses without a penalty tax. Although, they will still be subject to pay income tax on that specific amount. This is not true for those younger than 65.  Unfortunately, they may be subject to a 20% penalty tax in addition to the income tax.

What are Qualified Medical Expenses?

There is a list on the IRS website that defines qualified medical expenses.  Generally, these would be some expenses listed on the IRS' website under the Publication 502.  For simplicity, I have listed some common items covered:

1. Hearing aids
2. Breast pumps
3. Eyeglasses
4. Prescription drugs
5. Dental treatments
6. Co-Pays
7. Vaccines
8. Wheelchair
9. Vasectomy
10. Flu shot
11. Insulin
12. Infertility Treatment
13. Chiropractor
14. Ambulance

It should be noted, that these change regularly. If unsure, review the documents on the IRS website.  It is important to review and stay on top of the changes to prevent a 20% penalty.

Who Uses my HSA?

Per the IRS' Publication 969, I can use my HSA funds on anyone that is listed on my income tax return.  This includes my spouse, my dependents, and myself.  Even if your family may not be covered by your insurance, they can still utilize your HSA funds.

What Happens to My HSA After My Death?

Again, there is not a single answer to this question.  It depends on who the beneficiary is.  Upon inheriting, a spouse can maintain the HSA as if it were their own.  They can keep using the HSA for qualified medical expenses.  They can even use the funds as income after the age of 65.  Although, they will still be obligated to pay income tax on money not used for qualified expenses.

If the HSA beneficiary is not a spouse, than the account will no long be recognized as a health savings account.  The assets in the account will be distributed to the designated beneficiary.  Subsequently, these funds will be considered on the beneficiary's annual income tax.  Also, the inheritance will not receive any additional taxes or penalties other than the income tax.

In Summary

In conclusion, a health savings account (HSA) is a great savings and investment vehicle.  This is a way for me to save money by reducing my annual tax liability.  Additionally, it allows for me to invest my money.  The tax-free gains can be used for future, qualified, medical expenses.  Moreover, this will be crucial during the retirement years.

The account provides me the ability to invest and carry over a balance from year to year.  If I do not use it, my children will be able to use it once I am gone. Most importantly, the health savings account will grow long-term, while saving us money in the short-term.

Why not have one?  Do you invest your HSA funds?