What Are HSAs?

With the end of the year and tax time quickly approaching, I’m going to start focusing on various tax tips up until April 15th. Today’s topic: Health Savings Accounts (HSAs).

Health Savings Accounts (HSAs) are one of the most painless yet most underutilized tax instruments available. Here’s how they work:

HSAs are savings accounts where the funds must be spent on qualified medical expenses. The advantage is that, like many retirement accounts, the funds are contributed pretax. This means that the funds contributed to an HSA are a direct reduction to an individual’s Adjusted Gross Income (and thereby are available before income tax or FICA are assessed). For example, assume a person contributes $2,400 to an HSA and has an effective tax rate of 25%. The HSA contribution will reduce their tax bill by $600 – effectively turning the $2,400 into $3,000! But their utility goes even beyond that.

(See the note at the end of this article regarding use of HSAs by self-employed people. There are some important guidelines and special information to consider.)

How Do They Differ from Healthcare FSAs?

Healthcare Flexible Spending Accounts (FSAs) have the same pretax advantage as HSAs, have lighter requirements (see below), and are very popular offerings from employers. The disadvantage? For years, if you did not use the entirety of the contribution by the end of the year you lose it. Thankfully, last month the IRS changed the rule to allow for a $500 carryover to the next year for Healthcare FSAs. This is helpful, but it still has the chance of lost contributions and has no chance of growth over time.

Health Savings Accounts do not have this downside. If the funds are not used in the current year, they stay in the account (potentially earning interest/dividends) and continue to build with the contributions from the next year. So the funds do not go away until you tap into them. This next part is where Health Savings Accounts become very cool: once you turn 65 years old the money in the HSA can be withdrawn for non-health expenses. Essentially, the HSA functions as a secondary retirement account!

What Are the Health Savings Account Requirements?

As of the date of my writing this article, the requirements are as follows:

  • Must be covered by a high-deductible health plan (HDHP), which is defined in the table below
  • Must not be covered by any other health plan other than another HDHP (with limited exceptions)
  • Must not be eligible to be claimed as a dependent on another person’s tax return
  • Must not enrolled in Medicare

High-Deductible Health Plan Parameters

  2013 2014
Minimum Annual Deductible Individual: $1,250Family: $2,500 Individual: $1,250Family: $2,500
Maximum Annual Out-of-Pocket Costs Individual: $6,250Family: $12,500 Individual: $6,350Family: $12,700

“”

What Are the Maximum Annual Contributions and How Do I Set Up a Fund?

For 2013 and 2014 the contribution limits are as follows:

  2013 2014
Individual $3,250 $3,300
Family $6,450 $6,550

 

I know that some of this seems dry, uninteresting, and perhaps a little confusing. And that means a lot of us are probably inclined to shove it off to the back burner (or even further.)  But with a bit of help it’s really not that complicated and the benefits are meaningful. Generally your insurance agent or financial advisor can assist you with setting up an account and your contributions. Contributions to existing HSAs can be made as late as April 15, 2014 for the 2013 tax year! If you do not have one, please contact me and I will get you in touch with a qualified advisor.

Note #1: While HSA contributions do reduce federal income tax, state income tax for most states, and FICA taxes (if offered through an employer), they do not reduce self-employment (SECA) taxes. This is an often overlooked caveat since the SECA rate equals the sum of the employer and employee half of FICA taxes. But the two are technically not the same thing and HSA contributions do not reduce self-employment taxes.

Note #2: There has been speculation that HSAs may be done away with because of the recent changes in healthcare legislation and the government’s efforts to close as many tax havens as possible. While there is always the chance of this happening, it is not currently the case and this tax maneuver should still be taken advantage of when appropriate.

If you would like to talk about whether an HSA might be a good fit for your situation, visit me at FraimCPA.com or contact me and we can discuss the situation together.

IRS Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code.