Health Savings Account

The Health Savings Account or “HSA” was authorized by the Medicare Prescription Drug Improvement and Modernization Act of 2003 as a way to encourage consumers to manage their own health care costs.  As those costs continue to rise, Health Savings Accounts have come into focus as they are frequently included in discussions about health care reform.  Plan participants make tax-deductible contributions to their accounts and can then make tax-free withdrawals to pay for qualified medical expenses.

Eligibility to contribute to an HSA is based on enrollment in a high deductible health insurance plan (HDHP).  For 2017, that means any individual plan with an annual deductible of $1,300 or more ($2,600 or more for a family plan) and annual out-of-pocket expenses (deductibles, co-payments, etc., but not premiums) that do not exceed $6,550 ($13,100 for families). Over the past decade, the number of workers covered by an HDHP has grown from about 4% to nearly 25%.

Annual contribution limits are indexed for inflation.  For 2017, an individual may contribute up to $3,400 to his or her HSA, while families are limited to $6,750.  A “catch-up” provision allows plan participants age 55 and older to contribute up to an additional $1,000 per year.  Medicare recipients, dependents, or anyone who received Veteran’s benefits in the past three months are ineligible to make contributions to an HSA.

Unlike the more familiar Flexible Spending Account (FSA), which is only offered by your employer, you can open an HSA at a bank or other custodian whether or not your employer offers one.  Typically, the custodian issues a debit card that can be used at point of purchase to access funds on deposit in the HSA.  Other reimbursement options vary by plan.

What are the primary benefits?

Health Savings Accounts are a great way to save because they are triple tax-advantaged:

  1. Contributions are tax-deductible
  2. Earnings grow tax-deferred
  3. Withdrawals are tax-free if used for qualified medical expenses (for you, your spouse or dependents), including dental and vision (see IRS Publication 502, “Medical and Dental Expenses”).

That means you get a tax benefit for funding an account, your money is sheltered from taxation while it accumulates, and if you use it to cover medical costs, you’ll never pay tax on it.  It’s not just a “free lunch” – they even throw-in a coupon good towards your next medical expense! 

Furthermore, unlike with an FSA, there is no “use it or lose it” provision.  Assets in an HSA do not need to be spent within a particular timeframe, so you won’t have to scramble to find qualified expenses in order to avoid wasting the money you’ve set aside.  The money in your HSA can continue to grow – year after year – and it’s even portable: you take your plan assets with you when you change jobs or retire.

You do not need to be covered by a high deductible plan in order to maintain a pre-existing HSA or to take distributions from it – only to make contributions to it – so if you change employers and/or health plans, you do not need to liquidate your HSA, and you can still access the account, as needed, to cover out-of-pocket medical expenses.

What if I never get sick?

Plan assets do not have to be used to pay for medical expenses (withdrawals after age 65, or by the disabled, are subject to ordinary income tax but are not subject to penalty).  Instead, you can use your HSA as a supplemental retirement savings account.

Unlike with an Individual Retirement Account (IRA), eligibility for making a contribution to your HSA is based on your health insurance coverage and not subject to income limits or affected by enrollment in any other retirement savings plan, and there are no required minimum distributions.

Are there any drawbacks?

These plans are still fairly new, and the majority of custodians are banks, credit unions, and insurance companies that charge account maintenance and other fees.  Investment choices are limited and can be expensive, so it can pay to shop around.

Plan participants often have two accounts – an interest-bearing deposit account from which withdrawals are made and an investment account – and must transfer funds between the two.  Oftentimes, you must accumulate at least a certain minimum amount (typically $1,000 or $2,000) in the HSA before you can invest your money in anything other than the interest-bearing account.

Contributions and withdrawals (other than via a debit card) can be inconvenient, but some HSA custodians offer online contributions and withdrawals.  Penalties for making withdrawals for non-medical expenses are steep (20%), so be careful not to pull your HSA card out of your wallet when picking up the check at dinner.  HSA funds used to cover account maintenance fees, however, are not subject to taxes or penalties.

You cannot make contributions to an HSA if either you or your spouse is enrolled in an FSA.  You’re only allowed to withdraw funds actually on deposit in your HSA – not those you intend to contribute over the course of the year.

Tax-related

Prior year contributions can be made up until April 15 of the following year.  Contributions are reported on Form 8889-Health Savings Accounts and filed with your 1040 (page one, line 25), so they are not Schedule A Itemized Deductions.  Your custodian will provide you with Form 1099-SA (for distributions) in January and Form 5498-SA (for contributions) in May.

Upon the death of the plan participant:

  • If a spouse is the designated beneficiary, he or she will become the owner of the HSA without tax consequences.
  • If anyone other than a spouse is the designated beneficiary, the account ceases to be an HSA and is taxable to the non-spouse beneficiary.
  • If an estate is the beneficiary, the value of the HSA is includable on the decedent’s final tax return.

If your domestic partner is a tax dependent, he or she cannot open his or her own account, but disbursements from the participant’s account for a domestic partner’s qualified medical expenses would be tax-free.  If your domestic partner is not a tax dependent, disbursements for that domestic partner’s medical expenses would be subject to tax and a 20% penalty, but the domestic partner could instead open his or her own account (assuming he or she has HSA-eligible insurance).

You are permitted to make a one-time non-deductible transfer from an IRA to your HSA (subject to the HSA annual contribution limit), and the transfer will neither be included in income nor subject to an early withdrawal penalty.

What now?

If you are covered by a high deductible health plan but don’t currently have an HSA, you might be missing out on a better way to save for both medical care and retirement.  Make sure it’s on the agenda for your next meeting with your financial advisor.

Disclosures

All opinions and views constitute judgments as of the date of writing without regard to the date on which the recipient may receive or access the information, and are subject to change at any time without notice and with no obligation to update. This document is for informational and illustrative purposes only.  It should not be viewed as current or past recommendation or a solicitation of an offer to buy or sell any securities or investment products or to adopt any investment strategy.  Nothing contained herein should be construed as legal tax, accounting or investment advice. This material has been prepared by Lexington Wealth Management on the basis of internally developed data, publicly available information and other third-party sources believed to be reliable. Lexington Wealth Management has not sought to independently verify information obtained from public and third party sources and makes no representations or warranties as to the accuracy, completeness or reliability of such information.

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