One financial planning vehicle that does not get enough attention in my opinion is the Health Savings Account (HSA). Individuals who are enrolled in a High Deductible Health Plan (HDHP) become eligible to participate in an HSA. Usually, a HDHP will have lower premiums that are being paid for the cost of the insurance, but when you need to pay for medical services/procedures, the bills tend to be much higher due to this type of coverage. To combat this cost, some employers also make contributions to high deductible health plans for their employees. Additionally, by contributing to an HSA you are potentially assisting your current and future finances in three ways: tax deduction on the contributions, tax-deferral on invested funds, and tax-free distributions for medical purposes.

The HSA is a vehicle that allows you to contribute to an account which is used for medical purposes. Some companies have cards they give participants that are used like debit cards while others make you submit your medical expenses and then they provide you with reimbursement for the medical services. Understanding the ways to fund this account are important as they could impact your tax savings.

Tax Deductions on the Health Savings Account Contributions

There are two ways to fund your HSA. One is through your paycheck while the other is through a lump sum contribution. I generally prefer that  you fund your contributions through your paycheck as not only will you get an income tax deduction, but your contribution will not be subject to Social Security or Medicare tax.

The other solution is to fund the HSA in lump sum contributions. However, by doing this, you will still receive the income tax deduction on Schedule 1, Part II of your 1040 Tax Form, but you will not receive the benefit of the reduction in Social Security tax and Medicare tax.

Another great benefit of the HSA is you have until the tax filing deadline (not including extensions) to fund the account. That way if you were unable to contribute the amount you wanted to during the year, you can fund the account in a lump sum after year end. This strategy is great for when you have a medical need in the beginning of the current year and you have the funds available to contribute to the HSA for the prior year (as long as you haven’t hit the funding limit). If you contribute for the prior year, have the medical procedure performed and get reimbursed, you are getting a tax deduction for the prior tax year and are reimbursed for the medical expense you just incurred in a quick turnaround period.

Additionally, there is a provision called, the Last-Month Rule which also assists in contributing to your HSA.

The Last Month Rule

Under the last-month rule, if you are an eligible individual on the first day of the last month of your tax year (December 1 for most taxpayers), you are considered an eligible individual for the entire year. You are treated as having the same HDHP coverage for the entire year as you had on the first day of the last month if you didn’t otherwise have coverage.

Just so you know the limits on the contributions, please find the table below:

                                                                                       Contribution Limits for Health Savings Accounts

Tax Deferral on Contributed Funds

Another great benefit of the HSA is that your contributions do not necessarily have to remain in cash! Some plans allow you to invest your funds through a custodian. This is a good way to potentially increase your account value, however, it does come with the same market risks as traditional investment accounts, which is why I like to see these accounts invested somewhat conservatively.

Just when you may beginning to think HSA’s couldn’t get any better, there is more! At age 65, you are allowed to take funds out of the HSA and use them for other purposes outside of medical expenses. The funds would be subject to income taxes, but still another benefit to investing in an HSA.

Tax-Free Distributions for Medical Purposes

As mentioned earlier, you will receive a tax-free reimbursement for your medical expenses. A great strategy is to continue to invest in the HSA and utilize the tax-free nature of the reimbursements as you age. This will allow you to keep your funds invested in your other accounts instead of potentially incurring taxes.

Another area I wanted to point out is that although you generally cannot pay for medical insurance premiums with your HSA, you can pay medical insurance premiums in the following cases:

1) Long-Term Care Insurance

2) Health care continuation coverage (COBRA)

3) Health care coverage while receiving unemployment compensation under federal and state law

4) Medicare and other health care coverage if you were 65 or older (other than Medicare Supplemental Policies)

Tax Reporting and Additional Tax

Your HSA contributions and distributions are all reported on Tax Form 8889 on your Form 1040. Your W-2 will have your employer and your contributions in Box 12, Code W. If you have made any contributions after year-end, you also need to include that on your tax return. Tax Form 5498-HSA will have all contribution information to your account, but that form is generally released later than the tax return deadline, but before the extension deadline. Additionally, you will receive Tax Form 1099-SA for any distributions from your account.

Additional Tax

Sometimes participants take out funds from their HSA and do not use those funds for medical purposes. However, in doing so, you will be subject to substantial taxes. Not only will you incur regular income tax, but also a 20% additional income tax. This additional tax is reported on Tax Form 5329 of your tax return. Make sure you familiarize yourself with this additional tax and have it weigh into your decision upon using these funds for non-medical purposes prior to age 65.

In conclusion, the Health Savings Account can be a great arrow in anyone’s quiver due to their versatility.

Please feel free to reach out with any questions!





Michael Sherman, CPA, CFP®, CPFA, CDFA®
OWNER
Sherman Wealth Solutions LLC
Michael.Sherman@shermanws.com
O  980.350.0170
F   980.350.0180
www.shermanws.com

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