Health Savings Accounts
Solid Rock Wealth Management
A Health Savings Account (HSA) is the only savings vehicle that offers tax-deductible contributions, tax-deferred growth on the earnings plus tax-free distributions (for medical expenses).
Given the inevitability of medical expenses in retirement, arguably the best account for a portion of your retirement savings is a HSA. And, because there are now several HSA administrators offering the ability to invest your HSA money in mutual funds, you can earn greater investment returns.
Health Savings Account Rules
Contributions to a HSA are pre-tax (either tax deductible if contributed directly, or excluded from income if contributed by an employer on behalf of an employee). Withdrawals from an HSA for qualified medical expenses are tax free (although non-qualified withdrawals are taxable as ordinary income plus a 20% penalty tax, with the penalty waived for those over age 65, or who are disabled, or if withdrawn as a non-spouse beneficiary after the death of the HSA owner).
Qualified medical expenses are generally any expenses that would otherwise be eligible for the medical (and dental) expenses deduction, along with any expenses paid for a doctor-prescribed drug. Qualified medical expenses also include Medicare (but not Medigap) premiums, and even a portion of long-term care insurance premiums.
To contribute to a Health Savings Account, you must be covered under a High-Deductible Health Plan (HDHP), and not be enrolled in Medicare or other health coverage, nor claimed as a dependent on someone else’s tax return. A “high deductible” health plan must have a minimum deductible of $1,400 for self-only coverage or $2,800 for family coverage (in 2020), and can have a deductible as high as $6,900 for an individual or $13,800 for a family (in 2020).
In 2020, the maximum contribution limit to an HSA is $3,550 for an individual, or $7,100 for a family, plus a $1,000 “catch-up” contribution for those over age 55 (unlike retirement accounts, where catch-up contributions apply beginning at age 50).
Tax Treatment of Contributions and Distributions of HSAs
There is no time limit on when funds in an HSA must be used. An HSA does not have a “use it or lose it” provision like the Flexible Spending Account (FSA) where anything more than $500 of unused funds are forfeited at the end of the year. Instead, as long as they were permitted to be contributed into the HSA in the first place, HSA funds can remain in the account for an extended period of time.
In turn, the only requirement at the time of distribution for tax-free treatment from an HSA is that the withdrawal either cover a current medical expense, or be used to reimburse a prior one (that was itself paid out of pocket, was not reimbursed from another source, and was not previously claimed as an itemized deduction). This means that medical expenses can occur now and be reimbursed later (even far later) in the future and still be qualified, as long as documentation of the medical expense is maintained and as long as the medical expense occurred after the HSA was originally established. Alternatively, this means that funds can be contributed now to an HSA, and grow tax-free for years or even decades, before being used (tax-free including all those years of growth) for a distant future medical expense.
Even further extending the favorable deferral period for an HSA, the rules stipulate that if the HSA is not used before death, a surviving spouse can continue the HSA in his/her own name and continue the preferential tax treatment (including future tax-free withdrawals). This form of HSA spousal rollover is similar to that permitted for retirement accounts.
Chris Nolt is an independent, fee-only registered investment advisor and the owner of Solid Rock Wealth Management, Inc. and Solid Rock Realty Advisors, LLC, sister companies dedicated to working with families around the country who are selling a farm or ranch and transitioning into retirement. To order a copy of Chris’s book: Financial Strategies for Selling a Farm or Ranch, visit Amazon.com or call Chris at 800-517-1031. For more information, visit: http://www.solidrockproperty.com and http://www.solidrockwealth.com.
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