We often see Health Savings Accounts (HSAs) underutilized because individuals may not understand how to take advantage of the benefits. Some of this stems from the confusion between health savings accounts and flexible spending accounts.
At the beginning of each year, you must determine what goes into your flexible spending account (FSA). The maximum you can contribute is $5,000. Whatever you put into an FSA account must be spent by the end of the year or, with some exceptions, within 2 months of the end of the year. This is a use-it-or-lose-it account. You must be careful about what amount you put into this account to avoid overfunding.
Health Savings Accounts (HSAs) are different. Whatever dollars you put into them can remain there until you want to use those dollars. This is the major difference between HSA and FSA accounts. HSA accounts are not a use-it-or-lose-it. Extra dollars remain in the account until you want to use them.
To qualify for an HSA, you must have a high deductible medical plan. A high deductible plan for a single individual must have a minimum of a $1,400 deductible. For a family (any plan other than a single plan), the minimum deductible must be $2,800.
IRS states that if you are carrying single insurance, you can contribute $3,600 to an HSA account. Under the family plan, the contribution amount is limited to $7,200. All $7,200 can be put into one HSA account, or you can separate it into multiple accounts, your choice.
If you are over the age of 55, you can add an extra $1,000. The extra $1,000 must go into an account with the person’s name on it. Spouses would each have to have their own account.
Many have employers who contribute to an HSA. These dollars are not being taxed when received, and you do not take a tax deduction for what the employer puts in. You do have the option of putting your own funds in to reach the maximum funding amount. By funding the HSA, you know that you will have the safety net of having the deductible amount saved “just in case” a catastrophic medical expense occurs. If you do not have that catastrophic expense, the funds in the HSA can remain in the account until they are needed.
We often see individuals take advantage of the employer’s contributions and use them up. Once there are no longer any funds in the HSA, the individual begins to pay expenses out-of-pocket with after-tax dollars. This is where we see an opportunity to reduce the impact of medical expenses.
What if you took the time to deposit funds into your HSA and then pay those medical expenses out of the HSA? For example, consider that you have an upcoming dental bill of $3,000 for a root canal and a crown. Your employer puts $2,000 into your HSA, and you will need to come up with the balance.
Option one – you would write a check out or put the $1,000 onto your credit card. This means that the $3,000 bill would use up all your HSA and cost you the $1,000 out-of-pocket.
Option two – deposit that $1,000 into your HSA. Once the funds are in your account, use your HSA debit card or HSA checks and pay the remaining $1,000 dental bill. By depositing the $1,000 into your HSA account first you have created a deduction on your tax return. If you are in the 12% federal tax bracket, you will save $120 in taxes plus whatever you might save in state taxes. For NYS, that might be another $30. The net effect is that medical bill costs you $2,850 rather than $3,000.
If you are in even higher tax brackets, the savings would be even more significant. In the 24% plus 6% state, it would be a savings of $300. At 35% plus 6% state taxes, the savings would be $410. This savings is because you took the extra step of depositing the funds into your HSA before paying the medical bill.
The deduction for HSA contributions is an adjustment to income. It does not matter if you take the standard deduction or if you itemize, you still get to take advantage of getting the tax deduction for your contributions to the HSA.
HSA contributions generally accumulate in a bank account. That bank account earns interest. The interest will not be taxable if the funds are distributed to pay medical expenses. In addition to tax savings on the funds going into the account, if you leave funds in the account, you will not have to pay taxes on interest earned, creating further savings.
The earnings being non-taxable create an additional opportunity for long-term tax savings. The deduction for contributing to an HSA happens when the funds go into the account. You are not required to spend those funds now. Maybe you fully fund the HSA each year and elect to pay your medical expenses out-of-pocket to allow this HSA account to grow.
Let this account grow so that later in life, you have funds to pay medical expenses. If you want to retire before age 65, you could use this account to pay COBRA or other insurance premiums for a year or more when Medicare kicks in. These funds can be used to pay Medicare supplemental premiums. These funds can be used to pay out-of-pocket medical expenses, the “donut hole” expenses we often hear about.
Let the account grow to accumulate dollars for a medical procedure that your insurance might not cover. Think orthodontist bills! Let the account grow and use it if you become unemployed and need to pay insurance premiums out-of-pocket. This can be a saving to cover an unexpected, catastrophic medical expense.
Contributing the maximum to an HSA each year allows you to get the tax deduction. The interest the accumulated dollars earn in the account will not be taxed on an annual basis. If the funds are distributed to pay medical expenses, you will not have to pay tax on any distributions.
Whether you elect to use the HSA funds in the current year or hold them for future expenses, you must be using the funds in the same year that you incur medical expenses to avoid a taxable distribution. To be clear, you do not have to pay the expense directly from the HSA. If you have already incurred medical expenses this year, you can make that deposit into your HSA account today and reimburse yourself for medical expenses paid earlier in the year. Taking this step means you get the tax deduction when you file your 2021 tax return.
We recommend fully funding your HSA early in the year to allow for maximum tax-free growth. If you want to use it against medical expenses throughout the year, you can pay the bill directly from the HSA account, or you can reimburse yourself for several expenses at once. The only stipulation is – the calendar year that you take the distribution must be the same year that you pay the medical expense to avoid any taxation.
If you already have an HSA account set up with an institution that your employer makes deposits into, you can add your own personal contributions to that same account.
