St Tax Benefit: Contributions Are Tax
One benefit of using an HSA is that the money you choose to put into your account goes in tax free for federal income tax purposes. Contributions are typically made with pre-tax dollars through payroll deductions, so they are not included in your taxable income when you file your federal return, although state law may require you to include them for state income tax purposes.1 If you choose to make contributions with after-tax dollars, you can deduct that money from your income on your federal tax return.2* This means you can reduce your federal income tax for the next year! Its also important to note that the contributions to your HSA are available to you whenever you need them there is no use or lose rule like with Healthcare Flexible Spending Accounts. You will never have to worry about losing your contributions because your unused funds will always roll over into the next year. Read on about contributions and tax savings:
Who Is Eligible For An Hsa
People with an HDHP can open an HSA. The two are usually paired together, so youll be offered an HSA when you take out a qualifying plan.
You must also meet the eligibility standards set out by the Internal Revenue Service . An eligible individual is someone who:
- Has a qualified HDHP
- Has no other health coverage
- Is not enrolled in Medicare
- Is not claimed as a dependent on someone elses tax return
Taking The Tax Deduction
The entire amount deposited is tax-deductible on returns for that year, even for filers who do not itemize deductions.
Contributions by an employee directly from paychecks are made with pretax dollars, reducing their gross income. Employer contributions are deducted from taxable income by the employer, so they do not need to be itemized by the employee.
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How It All Adds Up
Your HSA is yours for lifethere is no use-it-or-lose-it rule, and the balance rolls over from year to year. With a careful balance of saving and spending, even with a modest rate of return on any investments, you have the opportunity to grow your account over time.
See how much your savings could add up over the next 20 years with our HSA balance and tax savings calculator..
1About Triple Tax Advantages: You can receive federal tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA. If you receive distributions for other reasons, the amount you withdraw will be subject to federal income tax and may be subject to an additional 20% tax. Any interest or earnings on the assets in the account are federal tax free. You may be able to claim a federal tax deduction for contributions you, or someone other than your employer, make to your HSA. State tax consequences for HSAs may vary. Bank of America recommends you contact qualified tax or legal counsel before establishing an HSA.
Tax Treatment For Hsa Contributions
Contributions to an HSA are tax-deductible on your Form 1040 tax return as an adjustment to income. However, you don’t have to take them as an itemized deduction for medical expenses, which is advantageous because itemized medical deductions are limited to expenses paid in excess of 7.5% of your adjusted gross income in the tax year 2022.
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Qualified Distributions Are Excluded From Gross Income
Distributions from your HSA that are used exclusively to pay for qualified medical expenses for you, your spouse, or tax-qualified dependents are excludable from your gross income. Your HSA funds can be used for qualified expenses and will continue to be free from federal taxes and state taxes for most states even if you are not currently eligible to make contributions to your HSA.
Understanding Health Savings Accounts
An HSA is a tax-exempt savings account that is available only to people who have high-deductible health insurance plans. The money can be used only to pay for qualified medical expenses. If the money is spent for any other purpose, the account holder has to pay income tax on the withdrawal plus a 20% tax penalty .
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Using The Money In The Account
Funds in the account can be used to pay for a wide-ranging list of qualifying healthcare expenses. These include prescriptions, doctor visit copays, mental health and addiction treatment, dental care, and vision care.
The list also includes the costs of alternative healthcare treatments such as acupuncture or chiropractic services. Fertility treatments, smoking cessation programs, service animals, and long-term care insurance premiums all are covered, as are many health-related products.
The IRS periodically updates its list of the allowed expenses. IRS Publication 502 has the current list and most insurers provide their customers with one.
Note: You can withdraw money from your HSA for any reason. It’s your money, after all. However, if the expense isn’t on the IRS-approved list and you’re not at least age 65, you’ll owe taxes and possibly a 20% penalty for the withdrawal that year.
Tax Differences Between Hsas Vs Fsas
If youve heard of HSAs, then you might also be familiar with FSAs, or Flexible Spending Accounts. Both are like emergency funds for medical expenses, but how they function out in the real world is pretty different. We break down all the need-to-know information about HSAs vs. FSAs here, but lets take a closer look now at their tax differences.
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Who Can Use The Hsa Money
The money in your account can be used for qualified health-care costs for yourself, of course, but also for any tax dependent.
“It doesn’t have to be someone who’s on your high-deductible health plan,” Durso said. “For example, your spouse may have coverage through their own employer, but you can still use the funds for their expenses.”
Hsas And Their Tax Benefits For Employers
Its no secret that health savings accounts provide many tax advantages. Those tax advantages are one of the main reasons why HSAs continue to gain steam in the marketplaceso much so that HSA accounts are expected to exceed 30 million by 2022.
But while HSA enrollment continues to grow at a rapid pace, most of the focus when it comes to HSA tax benefits revolves around individuals and employees. And while those HSA tax benefits are very real and very important, there are less publicized HSA tax advantages for employers that play an equally important role on the employer side. These employer HSA tax benefits should be anything but secret.
So, whether youre an employer already offering an HSA program to your employees, or if youre simply exploring the viability of an employer-sponsored HSA program for your business, you need to have a solid understanding of HSA tax benefits for employers.
Hsa Benefits For Employers Go Beyond Just Taxes
Employer tax benefits from HSAs are real. But there are also some HSA benefits employers can leverage that go beyond just taxes.
Offering an HSA program in and of itself and providing your employees with the opportunity to benefit for all an HSA offers directly benefits your business from both recruiting and retention standpoints. As HSAs continue to grow and gain traction, savvy employees and top talent will come to expect a competitive HSA program from their employer of choice.
Also on the employee front, employees who choose a high-deductible health plan and use an HSA are typically more cost conscious and tend to have lower healthcare expenses than other employees. Attracting and retaining these types of employees can lead to lower healthcare premiums for your company, which saves you money both short and long-term.
Consider The Bigger Financial Picture
Most HSA providers allow account holders to invest their holdings once they reach a certain balance. Just as you have a limited set of investment options to choose from in most 401s, your HSA provider typically offers a predetermined list of investments. Your Financial Advisor can help you select the best choices from the providers menu.
If you arent satisfied with the investment options or fees in the HSA offered through work, you can shop around and put money into an outside HSA plan. Keep in mind, though, that going with a different HSA account means your employer wont automatically deposit the money tax-free on your behalf or pay any administrative fees for maintaining the account, and your contribution will be subject to Social Security and Medicare tax. Youll have to fund the HSA with after-tax dollars throughout the year and then reconcile it on your tax return at the end of the year.
Of course, your HSA is just one piece of a bigger picture when it comes to your financial life. Decisions about whether to put money into an HSA, how much to save and when to use that money, should all fit into that bigger picture. Talk with your Morgan Stanley Financial Advisor today about how you can save for an optimal retirement and cover health-care costs later in life.
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Hsa Triple Tax Advantage
Now that you know a bit about the basics of an HSA lets dive into the unique advantages. Heres a closer look at the HSA triple tax advantage.
Tax-free contributions. The first tax advantage youll encounter through your HSA is that your contributions can be made tax-free. You might already be familiar with this type of tax advantage if you contribute to a 401 or traditional IRA.
Essentially, the funds you contribute to an HSA will be deducted from your taxable income for the year.
For example, lets say that you earned $50,000 in 2022. But you contribute $3,500 to your HSA. With that, your taxable income for the year would be lowered to $46,500.
A lower taxable income means a lower tax liability. So, tucking funds away into this account means your tax burden will be lower.
Tax-free growth. Next up, the funds you tuck into your HSA will be allowed to grow tax-free. Any investment growth or accumulated interest on your balance will be tax-free.
Depending on your investment strategy and your contributions, this tax-free growth could dramatically impact the balance of your HSA. Plus, there are no required minimum distributions each year.
With that, you can grow your HSA account every year. Of course, if you run into a medical issue, the account balance will take a hit. But thats what its there for! An HSA should be there to tap into when you have healthcare-related expenses to cover.
Who Qualifies For An Hsa
You must meet the following criteria to qualify for an HSA account:
- You are covered by a high-deductible health plan on the first day of the month
- You have no other health coverage except workers compensation, insurance for a specific disease or illness, a fixed amount of coverage per day for hospitalization
- You are not enrolled in Medicare
- You cant be claimed as a dependent on someone elses tax return
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Benefits Of Hsas For Your Retirement
HSAs come with three tax advantages that put them ahead of other savings or investment accounts. That includes: income tax-free contributions, income tax-free qualified withdrawals and income tax-free investment growth and interest earnings. With that as the basis for an HSA account, they offer a range of benefits. Heres how you can use them to your advantage during retirement.
Am I Eligible For An Hsa
To be eligible for an HSA, you must meet the following requirements set by the Internal Revenue Service :
- Have a high deductible health plan that meets the following requirements in 2022:
- Minimum deductible: $1,400 for individuals and $2,800 for families.
- Maximum deductible + out-of-pocket expenses: $7,050 for individuals and $14,100 for families.
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Keep Records Of All Hsa Distributions
If you take qualified distributions from an HSA you must keep records sufficient to show that:
- the distributions exclusively paid or reimbursed qualified expenses,
- the qualified expenses had not been previously paid or reimbursed from another source and
- the medical expenses had not been taken as an itemized deduction in any year.
Note: Do not send these records with your tax returnâkeep them with your tax records.
Strategies To Maximize An Hsa
Americans with access to an HSA have a few strategies to make their money go further.
The best way to get the most out of an HSA is to contribute the annual maximum. In 2021, individuals can contribute $3,600 to an HSA, or $7,200 for family coverage. Account holders age 55 and older can make an extra $1,000 in contributions.
Some employers will match employee contributions, but the combination of employee-employer contributions cant exceed the IRSs limit. Independent contractors and self-employed individuals can open an HSA too and receive similar tax benefits from the contributions if they have a high-deductible health plan.
Also, consider consolidating more than one HSA. This is a possible scenario if a taxpayer changed jobs and opened two different HSAs under two different high-deductible health plans. This would increase the account balance and open up the opportunity to invest.
Another option to reach that threshold is to transfer money held in an IRA or Roth IRA to an HSA. The money would grow tax-deferred and depositing a lump sum may allow more account holders to access a required minimum balance to invest.
Finally, invest! If the benefits plan allows it, its the best way to grow the account. Some plan administrators require a minimum HSA balance before the account holder can consider investing. Find out what this number is, and work towards it over time.
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Money In Your Account Can Be Invested
Account-holders who invest some of the assets in their accounts tend to have significantly higher average balances, according to the Employee Benefits Research Institute $22,496, compared with $2,296 for non-investors. Investors also had higher contribution amounts than non-investors .
A 55-year-old who contributes the maximum amount to an HSA every year until age 65 could see a balance of $60,000 from total contributions of about $42,000, assuming a 5% rate of return, the EBRI notes.
An aggressive, high-earning 45-year-old saving the maximum, including catch-up contributions when eligible, could see a balance of $150,000 at age 65. If the rate of return is 7.5%, which is feasible, the balance rises to $193,000.
Of course, an HSA is not intended primarily as a retirement savings vehicle. It’s there so that you can cover out-of-pocket medical costs from year to year. But it’s worth considering, as each unexpected medical bill arrives, whether you should tap into your HSA or leave it for a possible greater need down the road.
Fsa Annual Contribution Limits Are Lower
In 2021, you can contribute up to $2,750 into an FSA.8 Because FSAs are only available through employers, its possible your employer could set the limit lower than $2,750. With an HSA, however, an individual can contribute up to $3,600 or $7,200 for a family in 2021. The closer you get to those maximum contributions, the less you have to report as taxable income.
Who Benefits Most From Having An Hsa
The short answer: nearly everyone. You don’t need a high income to benefit from an HSA, says Carolyn McClanahan, a certified financial planner and founder of Life Planning Partners in Jacksonville, Fla. Even if you’re unable to contribute the maximum amount allowed, “there is value in putting anything away, and little savings add up,” McClanahan says.
This is especially true for younger people, she notes, since getting into the habit of taking advantage of an HSA can be a good way to form good savings habits.
Something to keep in mind, McClanahan says, is that high-deductible health plans, which you must have in order to be eligible for an HSA, have changed a lot. “The copay plans used to be a better deal, but now I think theyve constructed them so theyre not,” she says.
Even a person with significant health issues might find that a high-deductible plan, coupled with the ability to save tax-free in an HSA, is a better deal. “Where people get into trouble is if they have a really high deductible .” In that case, they need to either save up that money in the HSA or choose a plan with a lower deductible.
Include Your Hsa In Your Estate Plan
When you set up a traditional IRA, you name a beneficiary. The same applies to an HSA, wherein you choose someone to receive any unused funds following your death. Generally, deciding where your HSA assets go at that point falls into one of three categories:
- Your spouse is the designated beneficiary: Upon transfer, the HSA gets treated as if it belongs to your spouse. That means it continues to receive the same tax benefits.
- Your spouse is not the designated beneficiary: If the beneficiary is not your spouse, the HSA stops being an HSA. The accounts fair market value becomes taxable in the year you die to your beneficiary.
- Your estate is the beneficiary: The HSAs fair market value is part of your final income tax return.
Most people would choose their surviving spouse as the beneficiary. However, if you do not have that option, you may want to consider the most-tax efficient choice. One beneficiary might be in a lower tax bracket than the other, making it the stronger option. Naming your estate will likely lead to your HSA becoming a probate asset, though.
Because of complications like these, make sure you talk with a professional before you make your decision. An estate planner can help you with every step of the process, including drafting a will and minimizing taxes for your beneficiaries.
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