By Katie Cuccia Hebert, MBA

A health savings account (HSA) provides a triple tax-advantaged way for individuals or families covered by a high-deductible health plan (HDHP) to save for and pay for qualified medical expenses. 

Contributions made into an HSA are tax-deductible, grow tax-free, and are withdrawn tax-free if used to pay for qualified medical expenses, including medical, dental, vision, and prescription drug expenses. 

In response to the coronavirus pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act now allows for over-the-counter medications without a prescription and other health-related products to be considered qualifying medical expenses covered by an HSA. 

How Do I Qualify for an HSA?

An HSA is available to eligible individuals who meet the following criteria:

• Covered by an HDHP on the first day of the month

• Have no other health coverage

• Not enrolled in Medicare

• Not claimed as a dependent on someone else’s tax return

If your spouse has a non-HDHP and you are not covered under your spouse’s plan (you are covered under your own HDHP), you are still eligible for an HSA if you meet the above requirements. 

If you are covered by Medicare, you are no longer eligible to contribute to an HSA. However, you can use the funds in your existing HSA to pay for qualifying medical expenses not covered by Medicare. 

What Is an HDHP?

A high-deductible health plan in 2021 must have a minimum deductible of:

• $1,400 for self-only coverage.

• $2,800 for family coverage. Family coverage is anything other than self-only coverage (e.g., spouses with no children).

The HDHP must also limit out-of-pocket expenses the insured is required to pay, including deductibles, copayments, and other amounts (exclusive of premiums). The out-of-pocket limit for 2021 is:

• $7,000 for self-only coverage

• $14,000 for family coverage

We recommend contacting your health care provider if you are considering opening an HSA to ensure your plan is a high-deductible health plan and meets the HSA eligibility requirements. 

How Much Can I Contribute?

Much like IRA contributions, the IRS limits how much you can contribute to an HSA and the deadline for doing so. The maximum contribution to an HSA in 2021 is $3,600 for self-only coverage and $7,200 for family coverage. 

Individuals 55 and older at the end of the tax year may make catch-up contributions of an additional $1,000 per year (i.e., this would allow for a total contribution of $4,600 for a 55-year-old with self-only coverage). 

The contribution deadline is the tax filing deadline (April 15). 

These annual contribution limits apply to the total amounts contributed to an HSA, meaning the limits include both employer and employee contributions. For example, you have self-only coverage and have an HSA through your employer as an employee benefit. Your employer contributes $1,000 to your HSA annually. Because of this contribution, you can only contribute an additional $2,600 to max out your total contributions at $3,600. 

HSA accounts are individually owned (there are no jointly owned registration options for an HSA) and may be established at various financial institutions. Contributions must be made in cash; contributions of stock or property are not permitted. Once the contributions are made, the funds may be invested into various mutual funds and exchange-traded funds (ETFs), or they may remain in cash.

If you are looking for HSA providers, we often recommend clients take a closer look at Health Savings. Their platform is low-cost and has a wide variety of investment options to select from. There are, of course, many other providers out there, and if your employer sponsors an HSA, using that platform may be easiest.

What Expenses Are “Qualified Medical Expenses”?

An HSA will cover qualified medical expenses incurred by the account owner, their spouse, and the dependents claimed on their tax return. Even though the HSA is individually owned, the account owner may use the funds in their HSA to pay for qualifying medical expenses of other individuals in their household.

So, for example, if I have a dependent child, I can use funds from my HSA to pay for my child’s qualified medical expenses. 

Qualified medical expenses include:

• Medical, dental, and vision expenses

• Prescription and non-prescription medications

• Insurance premiums only if used to pay for the following:

  • Long-term care insurance

  • Health care continuation coverage (i.e., COBRA)

  • Health care coverage while receiving unemployment compensation

  • Medicare and other health coverage if age 65 or older (other than premiums for a Medicare supplement policy, i.e., Medigap)

Distributions for anything other than qualifying medical expenses are subject to ordinary income tax and an additional 20% tax penalty. However, if you are 65 or older, you may withdraw from your HSA for any reason without being subject to the 20% penalty, but you will be required to pay ordinary income tax on the amount withdrawn. 

Advantages

• Arguably the most significant advantage of an HSA is the potential for triple-tax savings—the contributions are tax-deductible, they can be invested and grow tax-free, and they are withdrawn tax-free when used to pay for qualifying medical expenses.

• There are no income requirements that limit one’s eligibility to contribute to an HSA. Any individual who meets the eligibility requirements may make tax-deductible contributions into an HSA.

• The account owner may designate beneficiaries, and if the surviving spouse is the beneficiary, the HSA will pass tax-free to the surviving spouse at death.

• If an individual has an HSA through their employer, their HSA is portable and will stay with them even if they change jobs.

• Any employer contributions to an employee’s HSA will not be counted as income to the employee.

• Any contributions an employer or employee makes to an employee’s HSA will not be subject to Social Security and Medicare taxes. These are often known as FICA taxes (Federal Insurance Contributions Act), which are 15.3% and shared between the employee and employer.

Disadvantages

• If the designated beneficiary is someone other than the surviving spouse, the HSA does not pass tax-free. Instead, the beneficiary is taxed on the account’s fair market value (FMV), adjusted for any qualified medical expenses the decedent paid within one year of the date of death.

Things to Consider

HDHPs have lower premiums and higher annual deductibles than other health insurance plans. While the cost savings this type of plan can provide may seem beneficial, it is important to review the terms of the HDHP you are considering and whether the plan is best suited for your health needs.

An HSA provides incredible flexibility and numerous tax advantages that are not found in most other types of accounts. With the cost of health care continuing to rise, establishing and contributing to a health savings account (HSA) early and allowing it to grow over time may significantly impact your financial future. 

There are several factors to consider when determining how an HSA will align with your financial plan. Speaking with a financial advisor can help you understand your options and decide which ones are right for you.

If you would like to find out more information or are nearing retirement and want to speak with a financial planner about the steps you should take, schedule a complimentary 30-minute discovery call with one of our Wealth Advisors.