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How Your Clients Can Benefit From Health Savings Accounts

Mar 30th 2016
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Health savings accounts (HSAs) were created in 2003 so people who are covered by high-deductible health plans could easily, and with ease, receive tax-preferred treatment of money saved for medical expenses.

We all know that the Affordable Care Act has thrust us into the position of having to know more about health insurance than we’d ever wanted to. In fact, not only do we have to ask about essential minimum coverage, but we also have to act as an advisor on medical deductions.

Before the Affordable Care Act, you could take medical expenses that exceeded 7.5 percent of adjusted gross income (AGI). Today, they have to be in excess of 10 percent of AGI. For example, your client’s AGI could be $100,000, and she would need to have in excess of $10,000 in medical expenses for them to be deductible. For most people, they cannot deduct medical expenses because of the 10 percent floor. However, there is a way to deduct medical expenses on the line.

If your client has a high-deductible plan, he or she may be eligible for an HSA. The 2016 HSA limits are below:

  Minimum Deductible Maximum Out-of-Pocket Contribution Limit 55+ Contribution
Single $1,300 $6,550 $3,350 $1,000
Family $2,600 $13,100 $6,750 $1,000

As shown above, if you are single and have a minimum health insurance deductible of $1,300 and a maximum out-of-pocket of $6,550, then you can contribute $3,350 to an HSA. If you are 55 or older, you can add an additional $1,000. If you have a family and your minimum deductible is $2,600, with a maximum out-of-pocket of $13,100, then you can contribute $6,750 to an HSA. If you are 55 or older, you can deduct an additional $1,000.

HSAs vs. FSAs
HSA plans are the cousin of flexible spending accounts (FSAs). In an FSA, an employee can put up to $2,550 into the plan for health reasons, before tax. (Note: There is also a dependent care component of an FSA that allows for a contribution of $5,000 per year.)

The problem with an FSA is that it is a “use it or lose it” plan. If you contribute the maximum of $2,550 into the plan, you have to use all of it before the end of the year that you made the contribution, or you lose the money. On the other hand, an HSA doesn’t have the same restrictions. For example, you can contribute any amount to an HSA, and if you don’t use the full amount for the year that you make the contribution, the amount just rolls over to the next year.

Distributions from an HSA used exclusively to pay for the qualified medical expenses of you or your spouse or eligible dependents are generally excludable from gross income. For the most up-to-date qualified medical expenses, see Publication 502.

Tax Benefits of HSAs
Contributions to an HSA grow tax-free. For example, any contribution that you make to an HSA plan can be put into an interest-bearing account, stocks, bonds, and mutual funds. Any money that is made within the plan is completely tax-free. Another example: If you have enough cash to supplement an HSA account over and above your employer’s contribution that is up to the maximum permitted by the IRS each year, you could build up a healthy nest egg for medical expenses incurred during retirement.

You may be thinking, “This is a great way for someone with a lot of medical expenses to pay for medical care and make that amount tax deductible.” However, HSAs can be used in other ways. Although not technically a retirement plan, HSAs function like a retirement plan in that the contributions are tax deductible, the money grows tax-free, and qualified distributions from an HSA are tax-free.

For example, let’s say you have a client that is a healthy family of four. Their health insurance plan meets the HSA requirements, they are participants in their employer’s retirement plan, and they want to put more money away that grows tax deferred and is tax deductible. You can suggest they max out an HSA account.

In 2015, Fidelity Investments did a study to find out the healthcare costs of retirees. Fidelity’s Retirement Health Care Cost Estimate revealed that the average retiree of 65 years or older will spend $245,000 in healthcare costs up through their retirement. Most people will pay for these medical expenses with money that was in a tax-deferred IRA. However, when the money comes out of the IRA (provided it is not a Roth IRA), it is taxable. If healthcare costs come out of an HSA, they aren’t taxable to the recipient. It’s a no-brainer.

A word of caution: Use HSA plans carefully. Distributions from HSA plans that are not used for qualified medical expenses are not only taxable, but they are subject to a 20 percent penalty. There are exclusions to the 20 percent penalty – if you are age 65 or older or the distribution was due to death or disability, but for the most part, the 20 percent penalty is required most of the time.

HSA plans can be very helpful for someone who has a lot of medical expenses and wants to make those expenses tax deductible. They can also be used as a tool for those who want another tax-deductible “retirement vehicle.” However, be very careful when using these plans as the latter because the penalty for taxable distributions is excessive.

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