A Health Savings Account as a Retirement Tool

Due to the high cost of health insurance, many taxpayers find themselves choosing a high deductible plan in an effort to lower their health insurance premium. For those who qualify, a health savings account (HSA) offers a way to pay for medical expenses with tax free dollars. The following information provides a general overview of the law to help you determine if you might qualify for an HSA and the benefits it can provide. The rules for HSAs, like all tax rules, are complicated and this article provides only an overview. Your personal circumstances may differ.

QUALIFYING FOR AN HSA

In order to be eligible for an HSA, an individual must:

  • Be covered by a high deductible health plan on the first day of the month. An individual who is covered by a high deductible health plan on the first day of the last month of the individual’s taxable year (generally December 1) is considered to be an eligible individual for the entire year so long as the individual remains eligible for the following 12-month period.
  • Not be covered by another health plan except for coverage under certain policies, such as disability, long term care and veteran’s benefits. Other allowed coverage exceptions are beyond the scope of this article.
  • Not be enrolled in Medicare.
  • Not be claimed as a dependent on someone else’s return.

A taxpayer can be eligible for an HSA even though the spouse is not eligible. If both spouses qualify for an HSA, they must each have their own HSA. There can be no joint HSA accounts even if a joint return is filed.

In addition to the individual’s eligibility, the health plan must qualify as a high deductible health plan. For tax year 2022 a high deductible health plan is defined as:

  • An individual health plan where the minimum deductible is $1,400 and the maximum annual deductible/out of pocket expenses for in network coverage is $7,050.
  • A family health plan where the minimum deductible is $2,800 and the maximum annual deductible/out of pocket expenses for in network coverage is $14,100. A family plan does not qualify if either the deductible for an individual family member or for the family as a whole is below the $2,800 minimum required deductible.
  • A plan meets these qualifications even if it provides for preventive services without a requirement to satisfy a deductible.

The minimum deductible amount which must be satisfied to qualify as a high deductible plan does change each year.

CONTRIBUTIONS TO AN HSA

Subject to the limitations set forth below, an eligible individual may make yearly contributions to an HSA. All contributions to the HSA must consist of cash. Contributions to the HSA for a taxable year may be made at any time during the year and until April 15 of the following year.

The contributions to the HSA may be made by the individual, or by someone on the individual’s behalf. In the case of an employee who is covered by an employer’s HSA, both the employee and the employer may contribute to the HSA in the same year.  Contributions made by an employer are not included in the employee’s income.

The HSA contribution limits for 2022 are:

  • For individual high deductible health plans: $3,650 less any contributions made by an employer
  • For family high deductible health plans: $7,300 less any contributions made by an employer
  • For eligible individuals who are 55 and over at the end of the tax year: an additional $1,000

The full amount may be contributed to the HSA for the year so long as the taxpayer was an eligible individual for the entire year, and did not change the type of coverage during the year. If either of these changes occurred then the contribution limits ($3,650/$7,300) must be adjusted. The maximum contribution is the sum of 1/12 of the contribution limit for the months in which the taxpayer was an eligible individual. An individual who became eligible in the last month of the year and deducted the full HSA contribution for that taxable year, will have to include in income all or part of the deduction in the subsequent year if he/she ceases to be an eligible individual in the subsequent year.

Contributions in excess of the limits are subject to a 6% excise tax. Excess contributions by an employer are taxable income to the employee. The excise tax is paid each year the excess contribution remains in the HSA account. The rules regarding withdrawing the excess contributions to avoid the excise tax are beyond the scope of this article.

HOW IS AN HSA ESTABLISHED?

An HSA is a tax-exempt trust or custodial account set up with a qualified HSA trustee. The trustee can be a bank, an insurance company or anyone already approved by the IRS to be a trustee of IRA accounts. The trustee of the HSA need not be the health plan provider. Setting up an HSA does not require an application to, or authorization from, the IRS.

BENEFITS OF AN HSA

An HSA is considered to have a triple tax benefit. The first benefit of an HSA is that a taxpayer who satisfies all the requirements previously discussed may deduct the contribution made to the HSA. This deduction is available whether or not the taxpayer itemizes deductions.

HSA contributions can be invested in stocks and mutual funds. The second benefit of the HSA is that any income earned by the HSA not taxable. This tax-free growth has the additional benefit of increasing the amount that would be available to pay for future medical expenses which may be much higher as you age.

The purpose of an HSA is to set money aside for the payment of medical expenses. When a distribution is made from the HSA to pay for eligible medical expenses, the third benefit provided by the HSA is that the distribution is not included in income. As a result, medical expenses are being paid with funds that have never been, and will not be, subject to tax. If the distribution from an HSA is for something other than qualified medical expenses, the distribution will be subject to income tax and may be subject to a 20% additional tax.

An HSA has no yearly distribution requirement thus allowing the invested funds to grow tax free until needed for the payment of eligible medical expenses. Distribution can only be made for medical expenses incurred after the HSA was established. Tax free distributions from the HSA can be made even if the taxpayer is no longer an eligible individual so long as the distribution is made for the payment of medical expenses.

A taxpayer who has contributed to an HSA and invested wisely has an added benefit at retirement. The taxpayer will have a dedicated fund which can be used to pay for medical expenses, which include long term care, without it affecting the retirement funds available to pay for living expenses. Furthermore, using tax free HSA funds to pay for medical expenses may reduce the need to withdraw funds from a retirement account that may be subject to tax.

While HSA distributions which are not used for the payment of medical expenses are generally taxable and subject to additional tax, there is a little-known exception. Once the taxpayer is 65 or disabled, HSA distributions that are not used for the payment of medical expenses are subject to income tax, but not subject to the 20% additional tax. Thus, the HSA would function in the same manner as an IRA.

An HSA can be another vehicle available to put money away for retirement. While there are eligibility requirements and contribution limitations for the HSA, there are no required yearly minimum distributions and no income limitations as there may be to establish other retirement plans.

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