Written by: Thomas Van Spankeren, CFA, CFP® | RISE Investments

  • A tax-advantage strategy to save for qualified medical expenses

  • Participant needs to be enrolled in an HSA-eligible high-deductible plan to qualify for contributions

  • Key benefits: upfront tax benefit, employer contributions & opportunity to grow account

  • Key limitations: tax burden for non-qualified expenses, limited healthcare plan selection & unfavorable tax treatment at death

What is an HSA?

An HSA is a savings account that allows eligible participants to set aside pre-tax funds for qualified medical expenses. To qualify for an HSA, the participant needs to be enrolled in an HSA-eligible high-deductible plan and meet other specific criteria.

Funds from an HSA can be used to pay for unreimbursed medical expenses including deductibles, co-payments, and other medical services not covered thru insurance. Unreimbursed medical expenses can be for current or prior medical expenses with best practice of keeping a track record of receipts.

Contributions to an HSA come with limits set by the Internal Revenue Service. The contribution limits include employer and employee contributions.

The contribution deadline for an HSA is generally April 15th.

Key Benefits of an HSA

There are three key benefits of an HSA plan:

Upfront Tax Benefits:

Employee contributions to an HSA plan are made on a pre-tax basis which reduces taxable income. The upfront tax benefit allows for lower federal, state (in most cases), and payroll tax liability.

Employer Contributions:

Employer sponsored HSA-eligible high deductible plans often come with an employer match as an employee benefit. The HSA contribution limits are a combined amount between employer and employee contributions.

Opportunity for Tax-Free Growth

HSA contributions can be saved and invested with potential for tax-free growth if used for qualified medical expenses.1 Utilizing an HSA for qualified medical expenses in later years is an effective strategy for many HSA owners.

Key Limitations of an HSA

There are three limitations of an HSA plan:

Tax Burden for Unqualified Expenses

Using an HSA for non-qualified expenses triggers a substantial tax burden. For those under 65, a 20% tax penalty applies, and the distribution is taxable. For those over 65, the penalty is waived but the distribution is taxable.

Limited Healthcare Plan Selection

Qualifying for an HSA requires being enrolled in a high-deductible health insurance plan. While these plans tend to offer lower monthly premiums, they come with higher deductibles which may be an issue if you have high medical expenses.

Unfavorable Tax Treatment at Death2

While HSA’s are great savings vehicle while living, the tax treatment at death are unfavorable.

1 California and New Jersey do not conform to federal tax treatment of HSA’s.

2 The taxable amount for a non spouse is full market value less medical expenses paid by beneficiaries within one year of owner’s death. If an estate is a beneficiary of an HSA, the HSA owner is taxed on final tax return

Conclusion

HSA’s can be a powerful tool to incorporate in financial plans as they plan for inevitable medical expenses. It is important to recognize the limitations of this vehicle when considering this option.

Related: Tax Season Is Over. Now What? Turning This Year’s Return Into Next Year’s Strategy

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