Author: Barbara Rizvi, CFP® Director of Financial Planning
While health savings accounts (HSAs) are well recognized as a tool for saving for medical expenses on a pre-tax basis, understanding how to maximize the power of these accounts can help position you for a brighter financial future.
There are many tax advantaged ways to save money but only the HSA provides a trifecta when it comes to taxes, allowing you to eliminate all tax burden to the IRS while gaining the added benefit of increased savings. Contributions are made on a pre-tax basis, grow tax-free and are distributed tax-free when used for qualified medical expenses.
If your insurance covers your spouse or any adult children under age 26 they may be able to open an HSA in their name as well. Anyone is eligible to open an HSA if they are enrolled in a high-deductible health plan (HDHP) as long as they are not enrolled in any part of Medicare, cannot be claimed on someone else’s tax return as a dependent and have no other health coverage (some exceptions apply). Keep in mind that an enrollee is not just the employee or primary insured, but anyone else the employee insures with their HDHP.
Similar to an IRA or 401(k) an HSA is owned by an individual (it cannot be jointly owned with your spouse) and you designate a beneficiary. If your spouse is your beneficiary, the HSA will continue for their benefit after your death. If you choose a non-spouse beneficiary, the account stops being an HSA at your death and the fair market value of the HSA becomes taxable to the beneficiary. (The amount taxable to a non-spouse beneficiary is reduced by any qualified medical expenses for the decedent that is paid by the beneficiary within 1 year after the date of death.)
You are probably aware that an eligible employee or their employer can contribute to their HSA but few realize that family members or any other person can also make contributions on behalf of an eligible individual. Annual HSA contributions are limited by the IRS. If you are the sole person covered by the HDHP and are otherwise eligible for the HSA, you can contribute up to the Self Only Limit ($3,550 in 2020). If your coverage is for an eligible individual and at least one other person (whether or not that person is HSA eligible per the above guidelines) the eligible individual(s) can contribute up to the Family Limit ($7,100 in 2020) to their HSA. For those age 55 or older you are allowed to contribute an additional $1,000.
Rules for Married People: If both spouses are eligible to contribute to an HSA account, the Family Limit applies for the household. The combined contributions to both HSA accounts cannot exceed the Family Limit.
Another little known fact is that there is no time limit on when you must submit medical expenses for reimbursement. You can reimburse yourself for qualified medical expenses incurred by you, your spouse or any dependents if the expense was incurred any time after you started your HSA. Your medical expenses in a given year do not have to be covered by contributions made in that same year as is the case with other types of spending accounts, like flex spending accounts (FSAs).
If you have access to assets other than your HSA to pay for current medical expenses, it typically makes sense to use those other assets instead of immediately withdrawing from your HSA to reimburse yourself. This practice, in conjunction with investing your excess HSA savings (rather than letting it set in a cash account), allows you also take advantage of the tax-free growth and withdrawals.
Generally, HSA funds can’t be used to pay for health insurance premiums; however there are exceptions which make HSA accounts a nice safety net. If you are unexpectedly unemployed or decide to retire before age 65, HSAs can be used to pay for COBRA. Similarly, you can use your HSA for health coverage while receiving federal or state unemployment compensation.
Having a sizeable HSA account as you enter retirement can help you avoid using less tax favorable assets (IRAs, selling stocks, etc.) to pay for Medicare premiums (excluding MediGap), long-term care premiums, and other out-of-pocket qualified medical expenses.
Accumulating receipts for qualified medical expenses over a long period of time can also result in a nice “nest egg” that can be submitted for reimbursement from your HSA as a source of tax free income at a later date. These reimbursed funds can then be used for anything you would like. Just make sure you retain all receipts as well as documentation of eligible medical charges in a file with your important documents in the event of an audit.
Young adults can also experience the benefits of HSAs. Many young adults remain on their parents’ HDHP until age 26. As long as neither parent claims an adult child on their tax return, the young adult can open their own HSA and start realizing the benefits of early HSA savings and contribute up to the Family Limit, even while they are enrolled on a parent’s plan. Remember, anyone can contribute to the young adult’s HSA account, so a parent or grandparent can make contributions on behalf of the young adult if they choose to do so. HSA contributions are reflected on the account-owner’s tax return, not the individual who may be funding the account.
As you approach age 65 be aware that once enrolled in Medicare, you can no longer contribute to your HSA. If you delay enrollment in Medicare past age 65, Medicare coverage is retroactive up to 6 months, so be sure to discontinue HSA contributions to your account 6 months prior to applying for Medicare.
Keep in mind that if you are 65 or older and collecting Social Security retirement benefits, you are automatically enrolled in Medicare Part A and can no longer contribute to your own HSA.
If you’re approaching age 65 and plan to continue working, you may be wondering whether to delay Medicare enrollment to maintain the tax advantages of your HSA fund. It’s important to review each situation individually.
If you work for a company with fewer than 20 employees, your employer-sponsored plan will begin paying secondary to Medicare, meaning that failing to enroll in Medicare could leave you with little to no coverage and result in stiff Medicare premium penalties later.
On the other hand, plans sponsored by a company with 20 or more employees pay primary to Medicare, so you remain fully covered if you opt to delay Medicare enrollment. In this circumstance, you could continue to make HSA contributions as long as you remain covered under your employer’s high-deductible health plan.
To learn more about how to best utilize your HSA account, speak to your financial advisor. He or she will help ensure you make an informed decision to help plan for your financial future.
About the Author
Barbara is a Certified Financial Planner (CFP®) and Director of Financial Planning with the Private Client Advisory and Financial Planning teams at First National Bank Wealth Management. She specializes in providing comprehensive and personalized financial planning that incorporates investment, retirement, tax, protection and estate planning strategies.