Health savings accounts (“HSA”) are one of the most tax-favored savings vehicles available to Americans. Since they allow for tax-deferred growth, funded with pre-tax dollars and not subject to taxes at withdrawal for qualified expenses —they are a great way to save money for future medical costs. In particular, the HSA could be a good way to help cover long-term care costs.
HSAs were first authorized by congress in 2003. An HSA is a savings account established in connection with a high-deductible health plan (“HDHP”). For tax year 2016, HDHP policies require the owner to pay a minimum deductible of $1,300 for a single person or $2,600 for a family policy. Once the deductible is met, there is generally a sharing of costs between the policy owner and the insurance company until a maximum out-of-pocket expenses amount is reached. For 2016, the maximum out-of-pocket expenses are $6,550 for a single person and $13,100 for a family policy. Starting in 2015, out-of-pocket limits for HDHPs under the Affordable Care Act (“ACA”) were slightly higher than the IRS’s limits on HSA-qualified HDHPs. But the IRS limits are what determine if an HDHP is HSA-compliant for tax purposes. This cost sharing reduces the insurance company’s costs and allows it to charge a lower premium for the policy. The idea behind an HSA is to allow those deductibles to be paid with pre-tax dollars. Many companies pair HDHP insurance policies with annual contributions to the HSA in the amount of the minimum deductible amount. Individuals may also add pre-tax dollars to the account. The maximum annual contribution allowed for tax year 2016 to an HSA (employer and employee combined) is $3,350 for an individual policy or $6,750 for a family policy. Individuals age 55 or older can make a catch-up contribution of an additional $1,000. This amount is indexed for inflation.
The beauty of these accounts is that money contributed to an HSA carries over at the end of the year and is allowed to accumulate. Furthermore, the funds can be invested in a variety of securities. This is particularly advantageous to younger individuals with fewer health care concerns. By maximizing contributions and investing the holdings, a fund can be created for future health care expenses. In particular, this can be one means of saving money for long-term care needs.
Obviously, the government is not going to allow people to save money completely tax free without strings attached. It is important to understand these limits to avoid penalties and unnecessary taxes. As mentioned earlier, only people enrolled in HDHP insurance policies may save money in an HSA. Once you enroll in Medicare, you may no longer contribute to your HSA. In order to receive tax-free status for withdrawals, money taken from an HSA can only be used for qualified medical expenses. These are the same requirements applied to medical expenses itemized on Schedule A (although expenses paid for through an HSA cannot also be itemized). HSA funds can also be used to pay for long-term care policy premiums, COBRA coverage, health care coverage while unemployed, Medicare or other health coverage once age 65 or older. Qualified medical expenses also include amounts paid for qualified long-term care services.
So the question is whether it is better to save money for long-term care costs or to buy a long-term care policy. The specific answer will vary according to a person’s situation and needs. However, the short answer is that a long-term care policy provides more coverage but has a sunk cost — money paid for the policy is not returned if long-term care is not needed. Investing money in a HSA will not provide as much coverage, but does preserve the wealth for those who end up not needing the care. Given none of us can predict which category we will fall in, one risk minimizing suggestion is to do a bit of both. Buy a long-term care policy to cover a base amount of costs and save some money in an HSA to cover the rest.
What happens if you save all this money and end up not needing it for medical purposes? First of all, congratulate yourself on your good luck. Not only are you healthy, but you still have access to your savings. After age 65, distributions from an HSA account are not subject to a penalty (there is a 20 percent additional tax on distributions not used for qualified expenses for individuals younger than 65). Money taken out for non-medical expenses will be subject to ordinary income tax. However, since no taxes were paid on the money contributed to the account, this results in a tax-deferred situation similar to saving money in a traditional retirement account. Upon death of an HSA owner, the spouse can assume the HSA as his or her own policy. Any other beneficiary must pay ordinary income tax on the fair market value of the account. Again, this treatment is comparable to a traditional retirement account.
Given the newness of HSAs, many people are not aware of their potential for financial planning. Furthermore, many companies do not offer this option to their employees. However, if this is an option to you, do consider using this as a savings tool for your future medical costs.
If you have any questions or would like to discuss this matter further, please contact a member of Withum’s Private Client Services Group at firstname.lastname@example.org.
|Ted Nappi, CPA/PFS, CSEP, Partner
To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.