Health Savings Accounts - Multiple ways to save tax dollars
Health savings accounts (HSAs) have become a common method of tax savings in recent years. As the cost of health insurance premiums continue to rise, high-deductible health plans (HDHP) have helped keep that cost down. The lower premium costs combined with pre-tax contributions and new limits on deductible medical expenses makes the utilization of HSAs beneficial for many households.
In order to qualify for HSA enrollment, you must be an eligible individual. In addition to being part of a HDHP, you cannot be covered by any secondary non-HDHP or Medicare, cannot be a dependent on someone else’s tax return, and you (or your spouse) cannot have a general use flex spending account.
An HSA allows individuals to pay for current qualified healthcare expenses while also saving for future qualified expenses on a tax-favored basis by providing three tax advantages - contributions, investment earnings within the account, and qualified distributions. All are exempt from federal income tax, Social Security and Medicare tax, and state income taxes (for most states).
When contributions are deducted from your wages, it considered employer contributions (which lower taxable wages), and contributions paid directly to the HSA are deducted on the tax return. Both methods achieve the benefit of reduced taxable income, however only the employer contributions are exempt from Social Security and Medicare tax. Personal contributions can be made anytime prior to the original due date of your tax return (April 15th for most). The contribution timeframe cannot be extended.
Medical expenses paid throughout the year are currently only deductible when amounts spent exceed 10% of adjusted gross income. Plus, the Tax Cuts and Jobs Act has doubled the standard deduction, which has reduced the need for many individuals to itemize their deductions. By using funds from an HSA, you are able to get the tax benefits when paying for qualified medical expenses. However, if the amounts are withdrawn for non-medical purposes, the distributions will be considered income and will also subject to a 20% penalty. The 20% penalty tax does not apply upon death, disability, or age 65 or older.
There are limits to the amounts that can be contributed each year. For 2019, you can contribute $3,500 for self-coverage ($7,000 family) per year. If you are age 55 or older, an additional $1,000 catch-up amount can be contributed as well. For 2020, the amounts increase to $3,550 for self-coverage ($7,100 family). If contributions exceed these limits, a 10% penalty tax will be assessed.
Overall, HSA accounts can be a very powerful tax tool when used correctly. They allow for money to be set aside tax-free, deductions for otherwise non-deductible medical expenses, and tax-free growth with any interest earned in the account.