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Health Savings Account Information and Potential Strategies

Posted in: Savings

Health Savings Account Information and Potential Strategies

While an HSA resembles a flexible spending account (FSA), which your employer may offer as part of your benefits package, there are also some significant differences. For example, the money in your HSA can be rolled over yearly, which isn't the case with an FSA. If you change jobs, you can take an HSA, but not an FSA, with you. And if you don't have access to an HSA through your employment, you can open one with a bank or other financial services company and deduct your contribution when you file your tax return for the year you contributed. That's not possible with an FSA.

If you change jobs, you can take an HSA, but not an FSA, with you. So why doesn't everybody have an HSA? A primary reason is that you must be enrolled in a high deductible health plan (HDHP) to be eligible.

The HDHP Connection
Federal law defines an HDHP as one having a minimum upfront deductible — $1,500 for individual coverage and $3,000 for family coverage in 2023 — that participants must pay out-of-pocket before the insurer begins to cover any health care costs. Your employer may offer such a plan, though the deductible may be higher than the federal floor. Or, if you aren't offered health insurance where you work, you may choose an HDHP on your own rather than traditional health insurance because traditional health insurance is likely to have lower or no deductibles but higher premiums.

The same federal law that sets the minimum upfront deductible puts a cap on your annual out-of-pocket medical expenses for 2023 at $7,500 for individual and $15,000 for family coverage. Those are the expenses the savings in an HSA are designed to cover.

Because of the HDHP-HSA link, you must first decide whether an HDHP is right for you. You'll also consider whether you'll contribute to a linked HSA up to the annual cap. In 2023, that's $3,850 for individual coverage and $7,750 for family coverage. If the HDHP is an employer plan, your employer may contribute part of that amount as an incentive to encourage you to choose the HDHP. That's because the typically lower HDHP premiums reduce employers' cost of providing health insurance.

You must first decide whether an HDHP is right for you. In addition to the lower premiums and tax advantages, HDHP-HSAs give you the flexibility to comparison shop among health care providers and more control over the prices you pay for health care — at least in theory. But that's not always the case. For example, if you're part of an employer plan, you may have to use the insurance company's network of doctors if you want your out-of-pocket expenditures to count toward meeting your deductible.

If you purchase an HDHP on your own, you may find it's not easy to compare costs, as doctors tend not to provide a schedule of prices. You may also have difficulty negotiating a lower price for services as an individual than a group plan can achieve.

Using a Custodian
If you have an employer-provided HDHP, your employer probably has selected a financial services company to act as custodian for participants' HSAs. This means that they administer the HSA plan. You can use a different custodian if you wish.

The advantage of using the designated custodian is that your employer will pay the administrative costs. It's also typically easy to arrange the direct deposit of your pretax money, which may not be the case if you use an outside custodian. The default account may be a money market or savings account that you can readily tap to pay your qualifying medical bills, either by submitting them for reimbursement or using a designated debit card. However, the interest rate on the account will probably be modest.

A Tax-Free Way to Save
If you can afford to fully fund your HSA and pay your out-of-pocket health expenses from your ordinary income rather than withdrawing from the HSA account, you can take advantage of an additional way to accumulate tax-free savings. That may be especially attractive if your modified adjusted gross income is too high to allow you to contribute to a Roth IRA. This way, you can draw on the funds in your HSA to cover your health needs when you're retired and likely spending more on health care than you have in the past.

To make this most effective, it's wise to contribute as much as you can to fund your HSA fully. When you turn 55, you can contribute an additional $1,000 in catch-up contributions annually for the next ten years, further boosting your account value. Contributions to an HSA can be tricky as you age into Medicare. An individual covered by Medicare is not eligible to contribute. Your options change if you choose to delay Medicare coverage beyond the age of 65, but you should know that if you do, your Medicare coverage will be applied retroactively for six months when you apply. For this reason, you should consult a tax professional if you choose to delay and continue making contributions. You should also keep in mind that if you use the money for anything other than health care expenses before you turn 65, you'll owe tax on the amount you take out of the account, plus a 10% tax penalty.

On the other hand, if you're trying to manage your current healthcare costs, HSAs can be a valuable tool for accumulating tax-free money to pay your out-of-pocket expenses. You'll owe less tax because what you contribute to an HSA isn't taxed, your earnings aren't taxed, and neither are your qualified withdrawals. So you're saving on taxes in three ways.

While there are many potential advantages to HSAs for meeting both immediate and long-term health care costs, you do have to determine whether you are willing to enroll in an HDHP to have access to this opportunity to save and whether you'll actually contribute enough to cover your costs.

Additional HSA Information and Potential Strategies

• Contributions to an HSA can be tricky as you approach Medicare.

• While you cannot contribute to an HSA while on Medicare, you may contribute beyond the age of 65 if you delay your Medicare coverage. In addition, your spouse may be eligible to make a family contribution if you are still covered on an HDHP together after aging into Medicare.

• If you are still on your parents' HDHP and not a dependent on their tax return (under age 26), you can also open an HSA, and because you are on a family plan, you can make the full family contribution.

• Anyone can contribute to your HSA. The owner of the HSA gets the deduction.

• If you are eligible to contribute on 12/01 of the year, you can make a full contribution. Tax-deductible contributions can be made up to the tax filing deadline of April 15th of the following year.

• Your contribution is deductible, not expenses incurred or paid for. The IRS allows you to "bank" your medical, dental, and vision costs and reimburse yourself anytime. You can carry them forward as long as you'd like. In addition, the IRS allows Part B premiums to be paid tax-free from your HSA, which makes the HSA a very tax-efficient vehicle for additional retirement savings.

• The IRS allows a one-time rollover from an IRA to an HSA account up to the maximum annual contribution limit plus catch-ups. This can be done in addition to your yearly contribution but has to be completed while you are still covered by an HDHP and not on Medicare.

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