One tax-efficient way to save for retirement healthcare expenses is through a Health Savings Account (HSA) coupled with a High Deductible Health Plan (HDHP). Even though the HSA savings vehicle was created in 2003, it has generally been misunderstood and is just beginning to gain legitimate acceptance. With the recent interest, many people have questions pertaining to these accounts. Below are some of the more common questions.
Q: What is a Health Savings Account (HSA)?
A: An HSA is a tax-exempt trust or custodial account created for the purpose of enabling you to save money by paying for qualified medical expenses in connection with a High Deductible Health Plan (HDHP) with before-tax dollars.
Q: Who owns the HSA and the contributions?
A: HSA dollars are owned by you, the account holder. Unused money automatically rolls over to the next year. It is not a “Use It or Lose It” situation.
Q: Can I take the funds in my HSA with me if I leave my current employer?
A: Yes. Balances in your HSA belong to you, including any contributions that your employer or anyone else has made. Your balance is fully portable.
Q: What are the tax advantages of an HSA?
A: Triple tax advantage:
- Employee and employer contributions are tax-free (IRS Notice 2004-2 Q&A 17).
- If contributed through payroll, contributions are not subject to FICA or Medicare taxes (IRS Notice 2004-2 Q&A 19).
- Interest and investment earnings on the balance are tax-free (IRS Notice 2004-2 Q&A 20).
- Withdrawals for qualified medical expenses are not taxed (IRS Notice 2004-2 Q&A 25).
The HSA allows savings for current or future medical expenses, meaning the unused funds can remain in the account year after year until needed for medical expenses.
Q: What are qualified medical expenses (QME)?
A: Expenses must be primarily to alleviate or prevent physical or mental defect or illness, including dental and vision. A full list can be obtained from IRS Publication 502.
Q: What if I withdraw money for expenses other than qualified medical expenses (QME)?
A: Any money from the HSA used for non-qualified medical expenses will be included in the individual’s gross income for tax purposes and subject to an additional 20% penalty on the amount included. The 20% penalty is waived if over 65 years of age. After age 65, an HSA acts similarly to a traditional IRA. Distributions can be made from an HSA for non-medical expenses, but ordinary taxes would be due.
Q: How do I contribute to an HSA?
A: The easiest and most tax efficient way is through before-tax payroll deduction, but you can also write a check or transfer money from another account.
Q: Who may contribute to an HSA?
A: An HSA may receive contributions from the employee or any other person, including an employer or a family member.
Q: When can I make contributions?
A: Contributions are tied to the tax year. Most individuals are calendar-year taxpayers. For such individuals, contributions can be made between January 1 of a given year and April 15 of the following year.
Q: What is the maximum contribution allowed per year?
A: The maximum is set by the IRS each year and is adjusted for inflation. With a few exceptions (listed in IRS publication 969, the 2017 contribution limit is $3,400 for self-only and $6,750 for family (employee and employer contribution). The 2018 limit is $3,450 for self-only and $6,850 for family.
For a summary of retirement plan and HSA contribution limits, download our 2018 Plan Limits Chart.
Q: What happens if I contribute more than the IRS limits listed above?
A: If you contribute more than the IRA limits during the year, it is called an excess contribution. An excess contribution is included in income and subject to a 6% excise tax (excess employer contributions are assessed in the same manner). You can avoid paying the excise tax if you meet the following conditions:
- You withdraw the excess contributions by the due date of your tax return for the year the contributions were made.
- You withdraw any income earned on the withdrawn contributions and include the earnings in “other income” on your tax return (IRS Notice 2004-2 Q&A 22).
Q: Is there a catch-up contribution available for those nearing retirement?
A: Federal rules permit “catch-up” contributions for those age 55 or older with an additional $1,000 per year above and beyond the normal maximum.
Q: Can a spouse make a catch-up contribution?
A: If each spouse is 55 or older, then both spouses must have individual HSAs for each to make a catch-up contribution. A married couple with two HSAs may make catch-up contributions totaling $2,000 in 2018 (IRS Notice 2004-2 Q&A 14).
Q: Can I still contribute to my HSA after age 65?
A: If you choose to enroll in Medicare at the age of 65 or older, you may still use your HSA for healthcare expenses. However, you will not be allowed to make additional contributions, as you will not be enrolled in a qualified HDHP. If you delay Medicare enrollment later than age 65, you can continue to make contributions as long as you are still covered by an HSA qualified HDHP.
Q: Can I invest my HSA?
A: Yes generally you can. Most HSA custodians, banks, administrators, and credit unions have some form of investment option available for HSA account owners.
Q: Can I use my HSA to pay for health insurance premiums?
A: Generally, you cannot treat insurance premiums as qualified medical expenses unless the premiums are for:
- Long-term care insurance (subject to IRS mandated limits based on age and adjusted annually, see IRS Publication 502: Long-Term Care).
- Health care continuation coverage (such as coverage under COBRA – see IRS Publication 502: COBRA Premium Assistance).
- Health care coverage while receiving unemployment compensation under federal or state law.
- Medicare and other health care coverage (Part B, Part D and Medicare Advantage) if you were 65 or older (other than premiums for a Medicare supplemental policy, such as Medigap).
Q: Whose qualified medical expenses can be covered by my HSA?
A: Individuals covered under the HSA include:
- You and your spouse.
- Any dependents you claim on your tax return (IRS Notice 2008-59 for additional qualifications).
- Any person you could have claimed as a dependent on your tax return (IRS Notice 2008-59 Q&A 33, IRS Publication 969).
Q: Can I pay for prior year medical expenses?
A: As long as the HSA was established before you incurred the medical expense, an HSA can be used to reimburse that expense years later. The key is to maintain good records of the expense. The IRS states, the HSA beneficiary “must keep records sufficient to later show that the distributions were exclusively to pay or reimburse qualified medical expenses, that the qualified medical expenses have not been previously paid or reimbursed from another source and that the medical expenses have not been taken as an itemized deduction in any prior taxable year.”
Q: Can an HSA be used for an emergency fund?
A: An HSA beneficiary can pay for medical expenses from a taxable account and save the medical receipts. Funds in the HSA continue to grow tax-free. When an emergency arises, you can seek reimbursement for past medical expenses sufficient to cover the emergency.
Q: How do I request distributions from my HSA?
A: Most HSA administrators allow for some combination of debit card, check, bill pay, or reimbursement for HSA-eligible expenses. You can only reimburse for expenses incurred after the HSA was established. The administrator is not required to determine if distributions are for qualified medical expenses. It is incumbent upon the HSA owner to maintain proper records and receipts.
Q: What is the best approach to maintain proper records and receipts?
A: If you need to substantiate a claim, you will need the original documents. Some HSA administrators provide mobile apps and document vaults to photograph, scan and store the documents. It is best practice to keep HSA records as long as the account remains open.
Q: What happens to my account when I die?
A: When the account owner dies, any remaining HSA balance passes to the entity or individual named as the HSA’s beneficiary. If the surviving beneficiary is the owner’s spouse, the HSA becomes the surviving spouse’s HSA. If the HSA passes to a person or persons other than a surviving spouse, then the HSA ceases as an HSA and the heir or heirs need to include the account’s fair market value in their gross income. If no beneficiary is designated, the assets will be distributed to the decedent’s estate.
Axia Advisory provides comprehensive HSA benchmarking and provider search services. If you are interested in evaluating your current provider or finding a new provider that better fits your needs, contact us and let us do the heavy lifting for you.