The Affordable Care Act (ACA) seems to be making Health Savings Accounts (HSAs) more popular than ever. A recent report issued by Devenir, an HSA industry participant, highlights two key findings:
- As of June 30, 2015, the number of HSAs had climbed 23% from the previous year to 14.5 million, and
- Account balances jumped 25% to approximately $28.4 billion over the same time period.
In 2010, the Employee Benefit Research Institute reported that there were 5.7 million HSAs with balances totaling $7.7 billion. Clearly, these accounts are becoming more popular.
Under the ACA, health insurance plans are categorized as bronze, silver, gold or platinum. Bronze plans have the highest deductibles and least-generous coverage, so they’re the most affordable. At the opposite end of the spectrum, platinum plans have no deductibles and more coverage, but they’re also much more expensive. In many cases, the ACA has led to significant premium increases — even for those who prefer more basic (and economical) plans.
Fortunately, some of the more basic plans also can make you eligible to make tax-saving HSA contributions. Those tax savings partially offset premium increases and skimpier coverage, leading to a surge in the popularity of HSAs.
An HSA is an IRA-like trust or custodial account that you can set up at a bank, insurance company or any other entity the IRS declares suitable, such as brokerage firms or credit unions. (You can find suitable HSA trustees with a simple Internet search.)
HSAs must be intended exclusively for paying qualified medical expenses. In other respects, they’re subject to rules similar to those that apply to IRAs. HSAs also may offer the same investment options as IRAs (stocks, mutual funds, bonds, certificates of deposit and so forth). But some HSA trustees may limit investment choices to more conservative options.
For the 2016 tax year, you can make a deductible HSA contribution of as much as $3,350 if you have qualifying high-deductible self-only coverage or as much as $6,750 if you have qualifying high-deductible family coverage. If you are age 55 or older as of the end of 2016, the maximum deductible contribution goes up by $1,000.
For 2015, the contribution caps are the same, except the maximum deductible contribution for family coverage is $6,650. These amounts are increased by $1,000 if you were 55 or older as of December 31, 2015. You have until April 18, 2016, to make an HSA contribution for the 2015 tax year.
You must have a qualifying high-deductible health insurance policy — and no other general health coverage — to be eligible for this HSA contribution privilege. For 2015 and 2016, a high-deductible policy is defined as one with a deductible of at least $1,300 for self-only coverage or $2,600 for family coverage.
For 2016, qualifying high-deductible policies can have out-of-pocket maximums of as much as $6,550 for self-only coverage and $13,100 for family coverage. For 2015, these amounts are $6,450 and $12,900, respectively.
If you are eligible to make an HSA contribution for a tax year, the deadline is April 15 of the following year (adjusted for weekends and holidays) to open an account and make a contribution for the earlier year. This is the same deadline as for IRA contributions. So there’s still time to make a contribution for the 2015 tax year.
The write-off for HSA contributions is an above-the-line deduction, so you needn’t itemize to benefit. Also, the HSA contribution privilege isn’t lost if you are a high earner.
Tax Treatment of Distributions
HSA distributions used to pay qualified medical expenses of the HSA owner and his or her spouse or dependents are free from federal income tax. You may build up a balance in the account if contributions plus earnings exceed withdrawals.
Any income earned is also free of federal income taxes. So, if you are in very good health, you can use your HSA to build up a substantial medical expense reserve fund over the years while collecting deductions and earning tax-free income along the way.
If you still have an HSA balance after reaching Medicare eligibility age, you can drain the account at any time. You will owe federal income tax on the withdrawals, but there’s no penalty. Alternatively, you can keep your HSA open and continue using it to pay medical expenses with tax-free withdrawals.
Thus, an HSA can function like an IRA if you stay healthy. Even if you have to empty the account every year to pay medical expenses, the HSA arrangement allows you to pay those expenses with pretax dollars. But there are some important caveats to bear in mind:
- HSA funds cannot be used for tax-free reimbursements of medical expenses that were incurred before you opened the account.
- If money is taken out of an HSA for any reason other than to cover qualified medical expenses, it will trigger a 20% penalty tax, unless you are eligible for Medicare.
According to the general rule, eligibility to make HSA contributions is determined on a monthly basis. So, when you have qualifying high-deductible health coverage for only part of the year, you can contribute and deduct one-twelfth of the annual limit for each month that qualifying coverage is in effect.
Under an exception to this rule, if you are eligible to make HSA contributions as of the last month of the year, you can be treated as eligible for the entire year and thus contribute the maximum for that year. While being able to make a full HSA contribution based on end-of-year eligibility is helpful, a harsh recapture rule may apply if you become ineligible for HSA contributions during the subsequent 12-month testing period.
The testing period begins with the last month of the tax year and ends on the last day of the twelfth month following that month. Any recapture amount must be included in your taxable income and incurs a 10% penalty. The risk of falling under the recapture provision may make it inadvisable to use the exception in order to make a bigger HSA contribution.
HSAs can provide a smart tax-saving opportunity for individuals with qualifying high-deductible health plans. If you’re eligible to make an HSA contribution for the 2015 tax year, you have until April 18, 2016, to open an account and make a deductible contribution. (For the 2016 tax year, you’ll have until April 17, 2017.) Completing the necessary forms takes only a few minutes. Consult with your tax adviser for more information about HSAs.
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