Contributions to your HSA
A Health Savings Account (HSA) can be a great health coverage option for the right person. In combination with a high-deductible health plan (HDHP), an HSA can offer flexibility, tax benefits, and catastrophic coverage. Once you have enrolled in an HSA-qualified HDHP, you can set up your HSA with the financial institution of your choice. Your health plan provider is required to have a trustee available for you to set up an HSA, but you don’t have to use that company unless you want to.
Banks, credit unions, insurance companies, and other financial institutions are permitted to be trustees or custodians of HSAs. Any institution that currently handles IRAs or Archer MSAs are automatically qualified to establish HSAs, but being qualified doesn’t mean they actually do. HSAs are fairly new, so some companies have not yet started to deal with them. As HSAs gain popularity, we will probably see more institutions offering them. For example, my credit union offers HSAs but my mutual fund company does not, even though they handle IRAs.
For convenience, you may want to first check with the financial institution you have your checking account with. Ask about monthly service fees, which are typically a couple of dollars a month. Also, each financial institution may have their own guidelines on minimum balances and minimum deposits, but the law states that an HSA can never have a negative balance. If you plan on funding your HSA gradually, a savings account is a good place to start building your HSA balance. A savings or money market account won’t provide much in the way of earnings, but the funds will be liquid and easily accessible if you need them.
When your HSA balance reaches the amount of your annual HDHP deductible, you may want to consider investing the rest for growth. You are allowed to put HSA funds in a variety of investment vehicles, including stocks, bonds, and mutual funds. Any investments that are allowed for IRAs are allowed for HSAs. You can have more than one HSA, i.e. an HSA in a bank savings account plus an HSA with your mutual fund company, but your total contributions to all HSAs must not go over IRS contribution limits, or the over-limit amount plus all of its earnings will be subject to income taxes and a 10% penalty. Having HSA funds in both a savings-type account and an investment account allows easy access to your HSA if you need it in the near future, and also lets you grow HSA funds for long-term needs in your later years, when health care needs are likely to become a larger expense.
An HSA can be activated on the first day of any given month as long as the HDHP is in effect by the first of that same month. If the HDHP won’t be in effect until, say, the 15th, you can’t activate your HSA until the 1st of the next month. You can get the paperwork and funding out of the way prior to your HDHP taking effect if you’d like to, but the HSA won’t be activated and usable until your HDHP is in effect. It is required, by law, that you have an active HDHP to contribute to an HSA. If you discontinue HDHP coverage, you can no longer contribute additional funds to your HSA, but the remaining HSA funds still belong to you and you may continue to use the HSA funds under the program guidelines, without penalty or taxation.
Contributions to your HSA can be made all at once, or you can make monthly, quarterly, or occasional payments to build up your funds. You can contribute for the previous year until April 15th of the next year, just like with an IRA. Keep in mind the 2008 annual contribution limit of $2900 for individuals and $5800 for family coverage. If you go over that limit, you may withdraw your excess contributions prior to April 15th of the following year, and will be required to pay income tax on the amount withdrawn, plus income tax on any interest that the excess contributions earned. If you don’t withdraw your excess contributions, you will be subject to a 6% excise tax of both the excess contributions and their earnings for every year that the excess contributions remain in the HSA.
The IRS allows a no penalty, no tax, once-during-your-lifetime irrevocable transfer of funds from your IRA to your HSA, up to the maximum contribution for that year, minus any previous contributions made during that year. This must be a trustee-to-trustee transfer, straight from one account to the other. You will be subject to income tax and the 10% penalty if you touch the funds yourself, even if you withdraw IRA funds and immediately deposit them into your HSA. Few will actually benefit by doing this; your IRA already has it’s own tax benefits and you’ll get more tax relief by funding your HSA with money from a taxable account.
You are also allowed a one time transfer of funds to an HSA if you have an employer-sponsored Flexible Spending Arrangement (FSA) or Health Reimbursement Arrangement (HRA) and are switching to an HSA. The transfers are not tax-deductible, so the normal contribution limits do not apply; you are allowed to transfer the amount of your FSA or HRA balance as of September 21, 2006, or if less, the entire balance as of the date of the transfer. This transfer is limited to one per FSA or HRA account and must be made before January 1, 2012. If you lose your HDHP coverage in the 12 months following the transfer, a portion of the funds may be taxed as regular income and subject to the 10% penalty.
Anyone, including your employer or family may contribute to your HSA on your behalf, but contribution limits still apply. If your family makes a contribution, you may still take the tax deduction. However, if your employer makes a contribution, that amount is not included in your income and so, therefore, cannot be taken as a tax deduction. You can still deduct any additional funds you personally contribute.
Withdrawals from your HSA
Using your HSA funds to pay for health care needs is pretty easy. Most financial institutions issue paper checks and a debit card for your HSA. Pay for your medical care just like you would with a regular debit card or check, but the funds come directly from your HSA. You may also request a cash withdrawal to be reimbursed for any qualified medical expenses you pay out-of-pocket. Nobody checks up on you and your expenditures; it is your responsibility to save all receipts and invoices as documentation of qualified medical expenses, in case you were to be audited by the IRS.
You can use your HSA to pay for qualified medical expenses for yourself, your spouse, and your dependant children, even if your spouse and children are not enrolled in an HDHP. The flexibility to use HSA funds for your immediate family is one of the great benefits of an HSA. Also, your HDHP coverage has nothing to do with what HSA expenses are allowed; you can use your HSA for pre-natal care even if you don’t have a maternity rider on your HDHP, and you can use your HSA for dental care, even though your HDHP does not cover dental. For a full list of qualified medical expenses, go to the IRS website to read Publication 502 at www.irs.gov/pub/irs-pdf/p502.pdf. Please take note that the IRS has recently updated the law to include many over-the-counter medications, even though it is not in Publication 502.
The neat thing about an HSA is that, in essence, you can now deduct the cost of medical expenses that are lower than what is allowed as itemized deductions. Let’s say one year you were particularly healthy, and your only medical expenses involved buying bandages, aspirin, a new pair of glasses, and getting x-rays and renting a pair of crutches for your child. The total cost for all these were $900. You are only allowed to take itemized deductions for medical expenses that exceed 7.5% of your income, and you made $35,000 that year. So, your medical expenses would have to exceed $2625 to claim the deduction, and even then you could only deduct the amount that’s over and above the $2625.
Now let’s say you’re in the same situation, except that you have contributed to an HSA, and you have at least $900 in the account. You are given the tax deduction for your HSA contributions without itemizing, and there are no restrictions about your income or the medical expenses being a certain percentage of your income. You basically put the tax-deductible $900 into the HSA, use the $900 to pay for qualified medical expenses, and get a tax deduction for an amount that wouldn’t have been possible otherwise.
In case of a year with excessive medical expenses, you may choose to pay your medical expenses out-of-pocket and itemize your deductions, rather than use the funds in your HSA, if it makes more tax-sense to do that. You can leave your tax-advantaged HSA to grow while choosing to do what is best for your tax situation in any given year. Just understand that you cannot take a tax deduction for medical expenses if you paid for them with your HSA, since the funds in the HSA have already been deducted from your income. So pay with your HSA and don’t itemize medical expenses, or itemize and pay out-of-pocket; just don’t take a double deduction or the IRS will get upset.
It’s best to let HSA funds accumulate; HSAs were designed for people to use them to meet current health care needs, as well as to save for their future health care needs. If you don’t need the money now, let it grow to help with your health care needs in retirement. There is a 10% penalty plus income tax due on any withdrawn funds that are not used for qualified medical expenses. The 10% penalty no longer applies once you reach 65, enroll in Medicare, or if you become disabled, but income tax will still be due if HSA funds are not used for qualified medical expenses.
If someone dies before HSA funds are depleted and their spouse inherits the HSA, then the surviving spouse will own the HSA, and may continue to use it for qualified medical expenses with no taxation or penalty. If the HSA is designated to go to anyone else, the account will cease being an HSA, so HSA guidelines will no longer apply, and the fair-market value of the account holdings will be taxed as income.
Sources:
The Department of the Treasury www.treas.gov
The Internal Revenue Service www.irs.gov
