I read an article about seven years ago that I happen to agree with.
It stated that in retirement, 75 percent of a retiree’s expenses are due to healthcare. What usually happens is the individual has a tax-advantaged 401k or IRA and has to take distributions from their retirement account to pay for these expenses.
The problem is, when monies are distributed from these retirement accounts, they are taxable to the recipient. To add insult to injury, medical expenses are subject to a percentage of adjusted gross income (AGI) and will most likely not be deductible.
A Health Savings Account (HSA) is different.
First of all, to qualify for an HSA in 2019, you have to have a high deductible health plan (HDHP). In 2019, an HDHP is $1,350 for individuals, with a maximum out of pocket of $6,750, and $2,700 for families, with a maximum out of pocket of $13,500. If these requirements are met, an individual can contribute $3,500 in 2019, and a family can contribute $7,000 in the same year.
The argument against these plans is that people will always state they and their families are healthy. However, unlike with the HSA’s cousin, a Flexible Spending Account (FSA), the unused portion rolls over from year to year.
In fact, an HSA has an investment component: If you have one, you are able to invest in securities. The best part is that it is tax deductible; above the line, no less, the money grows tax-free. And if the funds are used for medical reasons, when the money is distributed, it is tax-free as well. This is much better than having to take a withdrawal from a taxable retirement account.
If you are a self-employed C-corporation, you can start a Health Reimbursement Account (HRA), which is entirely employer funded. The amounts cannot be invested; however, they are tax-free if they are used for qualified medical expenses, as laid out in IRS Publication 502. The employer can also decide how much will roll over to the next year. The contributions aren’t limited, but if you have employees, you need to remember that what you do for yourself, you have to do for them.
When you lay the argument out logically to your clients, most of them will go along with an HSA or HRA. Both provide tax deductions. And in the case of an HSA, as I mentioned, the amounts can be invested in securities, which are sheltered from taxes. The contributions to both plans are tax deductible, and, if they are used for medical purposes, they are tax-free when withdrawn.
As you can see, these plans aren’t just great tax-planning tools: They can also be beneficial in retirement.
Craig W. Smalley, MST, EA, has been in practice since 1994. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as...