With the rising popularity of high deductible plans, understanding Health Savings Accounts (HSAs) has become an important component of financial management. HSAs offer triple tax benefits: tax-free accumulation, tax-free earnings, and tax-free distribution if you follow the rules.
Distributions made prior to age 65 are subject to a 20% penalty and current income tax but those age 65 and over can withdraw freely from their HSA and only pay current tax. This is similar to a 401(k) or other pension plan except deposits are not subject to Federal Insurance Contributions Act (FICA) taxes.
Thoughts from Craig Hasday
There are other ways you can take advantage of the HSA if you can afford the luxury, paying for qualified medical expenses with other taxable funds and allowing tax-free accumulation within the HSA also makes sense. There is no time limit on reimbursing yourself for these expenses – so you can accumulate bills for years, allow the HSA to build earnings tax-free and when you need it – add up those unreimbursed medical bills and take a tax-free distribution at any time.
So, it is probably better to maximize HSA deposits before making nonmatching 401(k) deferrals.
HSAs should also be considered in estate planning. Funds can be rolled into a surviving spouse’s HSA and the spouse can enjoy the same rights as the decedent spouse. However, if funds transfer to any other beneficiary, they are taxable to the beneficiary or to the estate (unless they are using funds for medical expenses within one year of the death).
Both spouses are eligible to establish their own HSA even if they are covered by the same qualified high deductible plan. And if over age 55, the HSA can be increased by the catch-up amount (currently $1,000). If the family has only one HSA, only one catch-up contribution is allowed even if both spouses are over age 55. Regardless of whether the family has one or two HSAs, the combined contribution cannot exceed the maximum allowable family coverage plus catch-up contributions even if one spouse is covered for self-only and the other a plan that includes their children.
HSA contributions may be made through payroll deduction or directly by an eligible person. The advantage of payroll deduction is that the employee’s share of FICA is also saved.
With increasing balances, don’t ignore your HSA. Maximize contributions, diversify your investments, optimize distributions and name your spouse as beneficiary.
National Employee Benefits Practice Leader