In the world of tax preferred savings plans the Health Savings Account is the crème de le crème. These accounts, commonly referred to by the acronym HSA, are the only accounts under IRS rules that allow tax deductible contributions, tax deferred growth or accumulation, and tax-free withdrawals when used for qualified health care expenses.
HSAs can only be established by individuals or families who participate in an HSA-compatible health insurance plan. HSA-eligible health insurance plans are typically insurance plans with higher deductibles and co-pays. In order to be compatible with an HSA, the plan must have an individual deductible of at least $1,600 and a family deductible of $3,200. In order to be compatible, the health insurance plan must also have an out-of-pocket maximum, which includes deductibles and co-pays, limited to $8,050 for individuals, and $16,100 for families.
The IRS also limits the amount of money which can be contributed to an HSA plan each year. In 2024, the limits are $4,150 for individuals and $8,300 for families. HSA users age 55 or over can also contribute a $1,000 catch up contribution, so if both spouses in a family plan are 55 or older the maximum tax deductible contribution is $10,300, which could result in quite a tax savings.
To get the full tax benefit of an HSA, including, of course, the tax-free withdrawal feature, HSA withdrawals must be made for payment of qualified health care expenses. Qualified medical expenses can include amounts paid to satisfy health insurance deductibles and co-insurance amounts but can also include unreimbursed expenses for dental visits, orthodontia, eyeglasses, prescribed drugs (even over the counter drugs recommended by a doctor), mental health expenses as well as transportation to medical appointments. There is a list of 82 qualified expense types listed on goodrx.com, and reviewing the list impressed on me the overall flexibility inherent with an HSA.
One common question we hear about HSAs, however, is whether they can be used to pay actual health insurance premiums. The answer is “sometimes” in very specific situations, which include only premiums paid for health care continuation coverage, commonly referred to as COBRA, after leaving a job, or for health care coverage paid for while receiving unemployment benefits. HSA withdrawals can also be used to pay for Medicare premiums by those 65 or older, but it's important to note this includes only Medicare Part A, Part B and Part D premiums, not Medicare supplement or Medicare advantage premiums. HSA withdrawals can also be used to pay long-term care insurance premiums, but are limited by age.
It's very important to be aware of how to properly use HSA withdrawals because non-qualified withdrawals are subject to a whopping 20% tax penalty as well as regular income tax. So, while these accounts can provide substantial tax benefits, it's also vital to learn how to properly use them to maximize benefits and avoid pitfalls.
Another common question involves the difference between an HSA and a Flexible Savings Account, or FSA. FSAs are common with larger employers and offer similar tax benefits to an HSA. Contributions to an FSA are typically done through payroll deduction and employers can also contribute to an FSA as a benefit to employees. A primary difference between the two types of plans, however, is that FSA are a “use it or lose it” benefit which can be forfeit by calendar year or separation from an employer, while HSAs follow an individual and not are based on calendar year or employment. This key difference enables HSAs to accumulate funds over time and serve as potential retirement planning solutions over the long term.
Speaking of retirement planning in the context of an HSA, IRS rules also allow a once-in-a-lifetime “rollover” of funds held in a Traditional IRA to an HSA. There are material stipulations and limits put on this process, but if planned for correctly, the HSA rollover may be the only way I am aware of that IRA funds may be utilized tax free, when of course, they are used for qualified medical expenses pursuant to HSA rules. I encourage anyone considering this type of transaction to seek qualified tax and financial advice on the process.
My family has used an HSA for many years. I find the account options and service on these plans to have greatly improved over time and our HSA has become an important part of our annual tax planning, and long-term financial planning at the same time. To me, funding the HSA in our family is a “no brainer.”
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. This material may contain forward looking statements; there are no guarantees that these outcomes will come to pass.
Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
