The time has come to talk about Health Savings Accounts (HSA). A HSA is one of the most unique and also beneficial piece of the health insurance process, but not a lot of people truly understand it and how it works. Let’s break it down one piece at a time.
What is it?
Your HSA is an investment account that can be used to pay for healthcare costs. Think of it as a financial account that is used to pay for medical expenses for you and any of your dependents, and, if you have a balance in the HSA you can invest that balance into the stock market to potentially make some money.
I heard there is a triple tax advantage for a HSA?
Yes! A HSA has 3 tax advantages. Let’s explore each one.
- Tax-free contributions. Money put into the HSA account is entered as tax free. This means if you put $1,000 into the HSA, you won’t ever have to pay taxes on that $1,000. The catch is, in order for the money to remain tax free, you have to use it for ‘qualified medical expenses’ (I define what qualified medical expenses are later). So, consider the alternatives like a Roth IRA or a Roth 401(k). While fantastic investment options in their own right, they both tax the contributions as you put them into the account which reduces the principal within the account. Finally, I need to point out there are annual contribution maximums for a HSA. The maximums typically increase each year due to inflation, thus the 2020 contribution maximums are: individuals can enter $3,550 and a family can enter $7,100 into the HSA for the taxable year.
- Tax-free growth. Now that you’ve entered money into the HSA, you now need to select your investment options. Think of a HSA as a money market account that has unique rules around healthcare. Like a money market account, you can enter money at any time with the intent to grow that money in the capital markets. Likewise, HSAs are designed for the users (i.e. you) to invest the money in the capital markets to make even more money. But here is the tax advantage. The gains realized from the HSA are tax-free. Seriously. If you put $1,000 into the HSA and realize a 10% return for 1 year, you now have $1,100 in the account – you made $100. That $100 can now be used for medical expenses and is you won’t have to pay taxes on it. Consider that $100 a gift from the government to keep yourself healthy.
- Tax-free distributions. Distributions are tax-free as long as they are for qualified medical expenses. To reiterate, you enter money into the HSA tax-free, you grow that money tax-free, and now you can take a distribution of that money tax-free when used for qualified medical expenses. Pretty good deal, right? Again, consider the alternatives. If you put that same money into a Traditional 401(k) or Traditional IRA the money would now be taxed as you pull that money out. But with a HSA the money pulled out for medical expenses is tax-free. And you can invest in the same stocks, mutual funds, etc. with the HSA as you would the IRA or 401(k).
So what’s the catch? As long as the money in the HSA is used for qualified medical expenses, there is no catch.
What happens if I take out money for non-medical expenses?
As a reminder, money taken from a HSA and used for medical expenses is always 100% tax-free. However, money taken out of an HSA for non-medical expenses depends on your age. If you are at least 65 years old, you can take money out of your HSA for a non-medical purpose and you will pay ordinary income tax on that amount. If you are less than 65 years old, you will pay both income tax AND a 20% penalty on that money. But again, any money taken out for medical expenses, regardless of age, is always tax free.
Can you define a qualified medical expense?
A qualified medical expense, interestingly, is defined by the IRS. Every year, the IRS updates and publishes a document called Form 502 which defines what a qualified medical expense is. Here is the link to the most current Form 502 (as of the writing of this article) and the following is the current definition.
Medical expenses are the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and for the purpose of affecting any part or function of the body. These expenses include payments for legal medical services rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes. Medical care expenses must be primarily to alleviate or prevent a physical or mental disability or illness. They don’t include expenses that are merely beneficial to general health, such as vitamins or a vacation. Medical expenses include the premiums you pay for insurance that covers the expenses of medical care, and the amounts you pay for transportation to get medical care. Medical expenses also include amounts paid for qualified long-term care services and limited amounts paid for any qualified long-term care insurance contract.
Translation: if you have to see a doctor, it’s covered. If you see a doctor and they formally tell you to buy something (i.e. glasses, medical device, etc.), it’s covered. If you get a doctor’s note for a massage, it’s covered. Just don’t try to qualify a vacation to the Caribbean…that’s not covered. But if you get sick while on vacation and pay to see a doctor, that’s covered.
How do I use an HSA?
There are two ways to use an HSA.
- Through your HSA card. When you setup your HSA account, you will receive a HSA card which looks and acts just like a debit card. When your doctor asks you to pay your bill, you can use your HSA card instead of writing a check – assuming you have enough funds in your HSA to cover the bill because it’s not a credit card.
- Keep your receipts and get reimbursed later. As of the writing of this article, the IRS does not have a statue of limitations on the timeline for reimbursement, nor has there been any rumors of placing one. What does that mean? It means you can pay for a doctor’s visit today, keep your receipt, and then be reimbursed for that doctor’s visit at some point in the future.
But why would I do that?
This is all about the time-value of money. If you have disposable income such that you don’t need immediate reimbursement, the money in your HSA that you would have used to pay the doctor’s visit will continue to grow tax free. So, let’s say your doctor’s bill is $100 and you do not request reimbursement for another 20 years. At a modest 6% growth rate, that $100 will turn into $320.71 which means you just made $220.71 for keeping your money in the HSA and not requesting reimbursement right away! Doing this at scale means you could potentially have significant growth in your HSA and also use the HSA as a tax haven for an alternative investment account – every little bit helps.
How do I fund a HSA?
A HSA can be funded three ways: 1) payroll deduction, 2) electronic fund transfer (EFT) directly from your banking account, 3) mail a check. The most common method is to fund via your payroll deduction which is beneficial for a couple of reasons. The first reason is this eliminates the need for you to remember to fund your HSA – out of sight out of mind. Secondly, automatically funding the HSA through payroll ensures you have a monthly baseline in your HSA account by which you can easily draw against. If desired, you can fully fund or add to the HSA at any time, but monthly deposits provide peace of mind that you have a guaranteed minimum amount of money in the account.
How do I set up a HSA?
While you must have a high deductible health plan to be eligible to invest in a HSA, the actual account is managed separately from your insurance. Here is a link to a few HSA providers for you to evaluate. Just call the HSA provider, provide them with information about your HDHP plan and they can walk you through their process to setup a HSA for you or your organization.
Can I use my HSA if I no longer have a high deductible plan?
Yes! Once money is placed in a HSA, it’s yours forever. And the way you are taxed still applies – i.e. tax free for all qualifying medical expenses and income tax and/or 20% penalty for non-qualifying medical expenses. The catch is that you must currently have a HDHP to fund the HSA. So if you no longer have a HDHP, you are not able to put more money in. However, once you go back to a HDHP, you can continue funding your HSA as if nothing changed.
Are there fees involved to have a HSA?
Yep, unfortunately, there are no free lunches. So, talk with a few HSA providers to determine the fee structure that makes the most sense for you or your organization.
Now that you know all about health savings accounts, you are ready to be quoted a high deductible health plan. Call us today to complete the process.
Sapper Insurance, 360-519-6990
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