As the debate over health care reform continues, there’s no reason why your clients can’t take matters into their own hands.
Strategy: Investigate the benefits of Health Savings Accounts (HSAs). Although these tax-favored accounts have been slow to catch on with the public, it might make sense for some clients. If it does, have them sign up for an HSA, whether or not health care reform is enacted.
Recent tax-law changes have improved HSAs, so they’ve become more attractive to a wider range of taxpayers.
Background information: The HSA is often called an “individual retirement account” (IRA) for medical expenses. Contributions can be deducted above the line or an employer can make tax deductible contributions on behalf of employees - or both.
As with a regular IRA, there’s no current income tax on the earnings within the account. Furthermore, distributions are completely tax-free if the funds are used to pay for qualified medical expenses. However, taxable distributions are hit with a 10 percent tax penalty if they are made before reaching age 59 1/2.
Who can qualify for an HSA? They are available to anyone who is not yet eligible for Medicare (i.e., someone under age 65), participates in a high-deductible plan, and does not receive coverage under another health insurance plan. For 2009, a “high deductible” plan is defined as a plan with a deductible of at least $1,150 and out-of-pocket maximum of no more than $5,800 for individual coverage; a deductible of at least $2,300 and out-of-pocket maximum of no more than $11,600 for family coverage. These limits are indexed for inflation.
Key point: For 2009, the maximum deductible HSA contributions are $3,000 for individuals; $5,950 for family coverage. (These figures are also adjusted for inflation.) In addition, a catch-up contribution of $1,000 is permitted for individuals age 55 or over (see chart for the HSA limits for the past five years).
Note that a 2006 law also authorizes certain tax-free rollovers to an HSA (see box, below).
HSA rollovers: A once-in-a-lifetime breakNormally, a taxpayer must pay tax at ordinary income rates when he or she takes a distribution from an IRA.
Strategy: Roll over funds from an IRA to an HSA. A one-time rollover is exempt from income tax as well as the 10% penalty tax that might otherwise apply to a taxpayer who is under age 59 1/2.
This method of funding an HAS - which was authorized by another 2006 tax-law change - is particularly beneficial for someone who is nearing retirement or has already retired. The maximum amount that may be rolled over is limited to the maximum HSA contribution allowed for the year.
Note that a taxpayer can roll over funds tax-free from an IRA into an HSA only once.
What happens to unused funds in an HSA? Any amount left over at the end of the year may be used to pay medical expenses in future years. Thanks to the higher annual contribution limits, employees can now accumulate even more in their accounts.
Advisory: This is a significant edge HSAs have over flexible spending accounts (FSAs) for health care expenses. Under the “use-it-or-lose-it” FSA feature, any amount remaining in your account at the end of the year is forfeited after a 2 1/2 - month grace period.
HSA limits continue to rise
The IRS adjusts the limits for HSAs on an annual basis. Here’s a capsule summary of the past five years.
|HSA contribution limit
|Catch-up contribution limit
Reprinted with permission from The Tax Strategist, November 2009. For continuing advice on this and numerous other tax strategies, go to www.TaxStrategist.net
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