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How Health Savings Accounts Impact Your Retirement

By: Investor Solutions

By: Investor Solutions

With healthcare costs spiraling out of control, many Americans are finding health coverage to be a growing concern. Many cannot afford health coverage altogether while others find it difficult to pay what their policies do not cover. The Health Savings Account (HSA) legislation was signed into law on December 8, 2003 making HSAs a fairly new concept that has experienced notable success in its short time in existence. In a nutshell, a Health Savings Account (HSA) is a tax sheltered savings account whose assets are used for medical expenses.

Characteristics of HSAs

  • Deposits are tax deductible. Taxpayers are allowed a deduction against their Adjusted Gross Income for contributions made to an HSA regardless of whether or not they itemize.
  • Earnings on the assets are tax free.
  • Distributions may be taken at any time tax free if used for qualified medical expenses for yourself, your spouse and your dependents.
  • An HSA is moveable meaning that if you switch jobs, you can take it with you. It does not stay with your employer.
  • Contributions to the account by your employer are excluded from your gross income.
  • Unlike the old flexible savings accounts, any remaining funds in the account at year end can be rolled over into future periods.
  • Withdrawals used to pay for something other than medical expenses prior to the age of 65 will be reported as ordinary income and subject to a 10% penalty.
  • After reaching the age of 65, withdrawals for expenses other than medical will be reported as ordinary income but not penalized.
  • Unlike IRAs, there are no required minimum distributions. However, there are lower annual contributions and fees on HSA accounts.

The Logic Behind HSAs

The logic of HSAs is that by increasing the deductible on your health plan, you would be saving on the premiums. This savings in premiums would, in turn, be deposited into an HSA to grow tax free and tax deductible and be used to cover the medical expenses prior to the point in which your insurance policy would begin to cover treatments. Alternatively, if the funds are not needed for medical expenses and you have reached the age of retirement, the monies in the account can also serve as retirement funds.

How to Qualify for an HSA

  • You have a high deductible health plan (HDHP). A HDHP is one with a higher annual deductible than typical health plans and a maximum limit on the aggregate amount of the annual deductible and out of pocket expenses excluding premiums. For individuals and families, the amounts of the minimum annual deductible are $1,100 and $2,200, respectively. The annual out of pocket expenses paid under the plan are limited to $5,500 and $11,000 for individuals and families, respectively. The out of pocket expenses include deductibles, co-payments and other amounts but does not include premiums.
  • You have no other health coverage. This does not include coverage for disability, dental, vision, long term care, workers compensation, accidents or specific diseases.
  • You are not enrolled in Medicare.
  • You are not claimed as a dependent on someone else’s tax return.
  • You are under the age of 65.

Permission from the IRS is not required to establish an HSA. In order to do so, however, you will need to contact a qualified HSA trustee such as a bank or insurance company. Basically, anyone already approved by the IRS as a trustee of an IRA can help you with an HSA. In order to find a qualified HSA trustee, visit www.hsainsider.com. Once established, contributions to an HSA can be made until the filing date of your tax return, excluding extensions or April 15th. Investment options within the account include bank accounts, CDs, annuities (which I don’t recommend), stocks, mutual funds, bonds and even real estate.

When establishing an HSA, it is important to select a beneficiary for the account. If you choose your spouse as the beneficiary of the account, upon your death, it will be treated as your spouses’ HSA. If instead, you leave it to a non spousal beneficiary, the account loses its HSA status and is taxable to the non spousal beneficiary the year you die. Lastly, if you fail to name beneficiaries, the account will be included in your estate and its value included on your final income tax return. Surely you can appreciate the importance of naming a beneficiary.

Recent Changes

The Tax Relief and Healthcare Act of 2006 has increased the amount of tax free contributions to the accounts in 2007 to $2,850 for individuals and $5,650 for family up from $2,700 and $5,450, respectively. Individuals that attain the age of 55 before the end of the tax year will be allowed an additional contribution of $800 for 2007. Additionally, workers who were hired midyear would no longer be penalized as they would be allowed to make the equivalent of a full-year maximum contribution to their account. Consumers would also be allowed a one time opportunity to convert existing Individual Retirement Accounts, Health Reimbursement Arrangements and Flexible Spending Accounts into HSAs.

Health Savings Accounts are excellent tax free savings vehicles individuals can use to help them accumulate funds in order to cover the high cost of health coverage and potentially save for retirement. Speak with your financial or tax advisor to find out if these plans are appropriate for you.