A Health Savings Account (HSA) is a trust account into which tax-deductible contributions can be made by qualified taxpayers who have high deductible medical insurance plans. Income earned on the HSA balance is tax-free. The funds from these accounts are then used to pay “qualified medical expenses” not covered by the medical insurance for an “eligible individual.” If these funds are not used, they roll over year to year. Once the taxpayer turns 65, the funds can be used like a retirement plan (taxable when withdrawn, but not subject to a withdrawal penalty) or saved for future medical expenses. Since the contribution is an above-the-line deduction, a taxpayer need not itemize to take advantage of this tax break. The rules discussed here are applicable to federal tax returns and may not apply to your particular state.
- Eligible Individual – For HSA purposes, the law defines an eligible individual as one who is covered by a “high deductible plan” and, while covered by that plan, is not also covered by another plan that does not have a high deductible. For purposes of determining if a plan does or does not have a high deductible, the law allows certain types of coverage, such as workers’ compensation, insurance for a specific condition, dental care, vision, long-term care and certain others, to be disregarded.
- High Deductible Plans – For 2016 and 2017, high deductible plans are defined as those with the following deductible amounts:
o Self-only coverage with an annual deductible of $1,300 or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, of no more than $6,550; or
o Family coverage with an annual deductible of $2,600 or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, of no more than $13,100.
- Qualified Medical Expenses – Qualified medical expenses that can be paid from these accounts are generally defined as those that would be allowable as a medical deduction on your tax return.
- Contribution Limits – The eligibility and contribution amounts for these accounts are determined monthly. Therefore, during any month in which you qualify, you would be entitled to contribute up to one-twelfth of the annual limits. For 2017, the annual limits (note these values are adjusted annually for inflation) are:
o $3,400 (up from 3,350in 2016) for single coverage plans;
o $6,750 (as in 2016) for family coverage plans; and
o $1,000 additional for individuals age 55 or older.
Individuals entitled to benefits under Medicare and those claimed as a dependent on another person’s tax return cannot make contributions. Contributions can be made as late as the due date of the tax return without extensions; contributions in excess of the allowable amounts are subject to an annual 6% excise penalty. If your employer makes the contributions for you through a payroll deduction plan, the contributed amounts are not subject to normal payroll withholdings such as FICA and taxes.
Example: John, a single taxpayer, age 58, begins a high deductible health plan with an annual deductible of $5,000 starting in March of 2017. We need to determine his maximum annual contribution limit, which is $4,400 ($3,400 plus $1,000 for being over 55). Next, we divide the annual limit by 12 to determine the monthly limit; in John’s case, it is $366.67 ($4,400/12). Since John was in a high deductible health plan for 10 months during 2017, his maximum contribution limit for 2017 would be $3,666.70 $366.67 x 10). If John were in the 25% tax bracket, he would realize a tax savings of $916.
- Non-Qualified Distributions – Distributions from an HSA are permitted at any time, and if used exclusively to pay for qualified medical expenses of the account beneficiary, his or her spouse, or dependents, are excludable from gross income. Amounts not used to pay for qualified medical expenses are includible in the account beneficiary’s gross income and are subject to a 20% penalty tax. However, the penalty does not apply if the distribution is made on account of the beneficiary’s:
o Disability; or
o Attaining age 65.
- Qualified Medical Expenses – are unreimbursed expenses paid by the account beneficiary, his or her spouse, or dependents for medical care, generally the same definition used for itemized-deduction medical expenses. The qualified medical expenses must be incurred only after the HSA has been established. Medical expenses paid or reimbursed by HSA distributions cannot also be claimed as a medical expense for itemized deduction purposes.
If you have questions related to Health Savings Accounts or how an HSA might suit your particular medical or retirement plans, please give this office a call.