How often does one find the need to balance financial priorities; college or retirement, emergency fund or the family vacation? Rarely, does an opportunity come through the tax code similar to what a Health Savings Account, HSA, provides. As it currently stands, a large portion of “traditional” health plans is going away, while being replaced with the high deductible care options in order to help contain costs. It is each employee’s responsibility to weigh options which may become a monumental task. Let’s examine what this tool is and how to use it.
What is an HSA?
An HSA is a tax-favored account used in conjunction with a high-deductible health insurance plan. The account should receive funds for healthcare related expenses. The list of possibly covered items includes things like some premiums (please see IRS Publication 502 for more details), deductibles, vision, and dental expenditures.
As previously mentioned, one needs to be covered under a high deductible plan in order to have an HSA. For an individual, the plan must have a $1300 deductible and $2600 for a family. Contribution limits to the plan are capped at $3350 for the individual and $6650 for a family. Additionally, anyone over the age of 55 may contribute another $1000 for the year.
How does the HSA work?
With your plan, contributions are tax deductible as an adjustment to income and the distributions are tax-free if used for qualifying medical expenses. Once your insurance deductible has been met, your insurance provider will cover expenses in accordance to the plan provisions. You may use the HSA funds as previously noted to cover premiums in addition to hearing aids, eyeglasses and contacts, chiropractor, stop smoking programs, and several other items. However, funeral expenses, cosmetic surgery, and weight loss programs are not covered. (For a full list of covered and ineligible expenses, please check with your HSA provider.)
The other important aspect of the account is the fact you may keep the monies in the account as long as you need them. It is a “not use it or lose it mandate” similar to a flexible spending account making the HSA more attractive for longevity. In fact, you may even be in a position where you contribute and later move to a non-high deductible plan and still withdraw funds for qualified expenses from the account.
How can an HSA be used as a retirement income supplement?
One of the lesser known provisions of the tax code involves the fact anyone over the age of 65 may withdraw funds from an HSA for living expenses. Pre age 65 withdraws for ineligible expenses are included in taxable income and subject to a 20% penalty. For age 65 or older, withdrawals for non-medical expenses, the amount is taxable, but the penalty is avoided.
Other noteworthy aspects currently include, currently no required minimum distributions, the account may initially be funded with one year’s deductible from an IRA or Roth IRA (ongoing SEP’s and Simple IRAs are not eligible), and many providers have investment options attached to the account.
If you do elect to use the investment options, make sure you keep enough cash available to cover your medical expenses. The excess funds invested may be used as a backup in case the liquid portion of the account is spent.
The health savings account allows a family to maximize contributions while not feeling comprised about saving for retirement.
Most importantly, the HSA should not be used as a replacement for retirement savings accounts, but rather as a supplement. As mentioned earlier, the penalty for nonqualified expenses is 20% versus the 10% penalty on most IRAs. The contributions, if coverage is for a single individual, are lower when compared to IRAs. If investment options are available, there is usually only a hand full.
Review your health care plan options with your employer or insurance agent. Weigh your options and include the HSA as part of your overall financial picture.