Health Savings Accounts, or HSAs, provide the best tax benefits currently available. Contributions are pre-tax, and withdrawals can be tax free as well. In addition, funds in HSA accounts may be invested, and income and capital gains within the account are also tax free. In order to establish or make contributions to an HSA, the owner must be enrolled in a qualifying high-deductible health insurance plan. Other characteristics that are unique to HSAs:
- The owner of the account may select the custodian. Over 500 banks currently offer HSAs.
- The account belongs to the owner and is not tied to the employer or the plan.
- Balances roll over and do not have any “use it or lose it” conditions.
- Although withdrawals are taxed as income plus a 20% penalty if used for purposes other than health care, the penalty is waived for those over age 65. This causes the account to be similar to an IRA or 401(K) for tax purposes.
- Contribution limits are $3,500 single or $7,000 per family for 2019. Over 55 are allowed an additional $1,000 catch-up contribution.
According to Kaiser Family Foundation, 58% of employees whose employers offer a health care plan are offered at least one plan that meets the HSA requirements (for 2019), but only half of those eligible choose the HSA option.
How does a plan meet the requirements for HSA eligibility? The high deductible requirements are best known. For 2019, the plan must include minimum $1,350 deductible ($2,700 for families) and maximum $6,750 out-of-pocket expenses ($13,500 for families). There are other requirements as well, the most important being that the plan may offer no benefit beyond standard negotiated rates prior to the deductible being met. This means that common benefits such as co-pays for pharmaceuticals or doctor visits are not allowed. The employer may offer plans that are HSA eligible without offering to administer the Health Savings Account itself, so employees should check to see if that is the case for any high deductible plans they may select. The employer or the insurance company can answer that question.
Navigating the choices involved in HSAs is an area where a financial advisor can really help a client.
- Consideration of annual health care expenses and current levels of savings or emergency funds. Expenses would include the employee cost of plans offered, expected use, and worst case planning. The legwork here includes not only cost of premiums vs. possible tax savings, but the increased expense of any maintenance medicines and services that the client requires on an ongoing basis.
- Selection of custodian. Custodians all have expenses, and these vary widely. In addition, investment options within custodians differ. They may include savings account only with fixed rate earnings, to CDs, to choice of mutual funds. Vanguard explicitly lists only HealthSavings Administrators (healthsavings.com) on their website.
- Tax treatment. Not all states allow HSAs to claim the same tax benefit.
- Strategic use of HSA funds. An HSA may pay for prior years’ eligible expenses (but not prior to establishment of the HSA). If a client is able to pay their medical expenses as they go out of taxable funds, and they save their receipts, then in the event that they need emergency funds, they can take funds from the HSA up to that total.
- HSA can pay any sort of medical expense, not just expenses that might be covered by the insurance plan: Physician and hospital expenses, laboratory expenses, prescription drugs, and also vision expenses (including glasses and LASIK), hearing aids, and dental expenses. Over-the-counter items are eligible, although many require a doctor’s prescription for reimbursement. You can find lists online to check specific requirements. Here’s one from Cigna: https://bit.ly/2yDSaEx
- HSA can pay Cobra premiums and Medicare premiums.
- HSAs cannot be used if the beneficiaries also have set up access to a Flexible Spending Account.
- Eligibility for contributions ends with Medicare enrollment. Those over age 65 who have deferred Medicare may still make HSA contributions if they are covered by an eligible plan.
Health Savings Accounts offer great tax benefits, but they are not the best choice for everyone.