The unicorn is having a moment. This mythical creature has been summoned to describe everything from a trendy Starbucks drink to trendy (slang) for a special sweetheart and now, to describe the Health Savings Account. To appreciate the “magic” of HSAs is to first understand how they work. Hint: April 15 has a whole lot to do with why these arrangements are so unique (and so coveted).
ABCs of HSAs
Propelled by soaring costs and prices, the United States spent far and away the largest share of the GDP on health care of 35 Organization for Economic Co-operation and Development (OECD) member countries. At more than 17% of the GDP in 2019 (the latest available figures for this report), the U.S. led in this dubious distinction by a considerable percentage; the next highest health care spends as a percentage of GDP spanned Switzerland, Germany and France at 12.1%, 11.7% and 11.2%, respectively. The OECD average approached 9%.
If trends hold, the Centers for Medicare & Medicaid Services (CMS) forecasts that health care spending will grow at 5.4% each year – climbing to $6.2 trillion in 2028. Put another way, health care expenditures would account for almost one-fifth of U.S. GDP within eight years if this pace continues.
Health Savings Accounts (HSAs) are designed to help cushion the blow to your financial situation from the high cost of health care. Maybe, you have set aside funds on an ongoing basis for a goal get-away or a new set of wheels. HSAs are like setting aside some funds on an ongoing basis to go toward future expenses – related to health care. Unlike most places where you “park” your money for some time, however, HSAs provide a trifecta of tax benefits:
Tax-free contributions
Tax-free growth
Tax-free withdrawals
Any party can contribute to your account, including employers and family members. This differs from other programs designed to help pay for health care services, including Health Reimbursement Arrangements. HRAs, for one, stipulate that contributions come from the employer only. Contributions are limited to cash; stock, property and other like assets are not counted as a qualifying contribution.
Not everyone is eligible to establish such an account in the first place, though. To qualify, you must:
Be enrolled in a High Deductible Health Plan
Not carry most other types of health insurance, unless it is specialized and permitted by law (i.e., for a specific condition or disease, or to cover specific services such as dental and vision)
Are not a Medicare enrollee
Are not claimed as a dependent by someone else for tax purposes
HDHPs are increasingly common. HSAs are structured to provide respite during the period when policyholders face health care costs. But those costs aren’t covered yet, because the policyholder hasn’t met his or her high deductible, which is at least $1,400 or $2,800 (the minimum annual deductibles listed by the IRS for HDHP self-only coverage and family coverage, respectively, in 2020). So, money from an HSA may be put toward the deductible. After the deductible is met, coverage kicks in.
Depending on your specific plan’s provisions, some preventive services may not be subject to deductible requirements. Alternately, services characterized as “preventive” may be subject to a lower deductible. Examples of such preventative care include annual physicals, smoking cessation programs, cancer and other screenings, weight loss programs (among obese patients), and any diagnostics that doctors may order as the result of exams.
The type of HDHP that you have also plays a role in the amount you can contribute to the account on an annual basis. Your date of eligibility and your age are also factored into your contribution limits. For instance, if you have “self-only” HDHP coverage, you can contribute up to $3,550 in 2020. The contribution limits for family HDHP coverage are exactly twice as much as the limit associated with self-coverage (at $7,100). These limits reflect an increase of $50 and $100 respectively between 2019 to 2020.
Employers or you as an accountholder can generally make contributions during the calendar year until the April 15 tax deadline. A notable advantage to this arrangement, any unused funds immediately roll over the following year without penalties levied against the account. In fact, some accounts even pay tax-free earnings in the form of interest on unused monies. Also, in no way do the “roll over” funds reduce your annual contribution limit.
As its name suggests, the savings in this account must go toward health expenses. At that, not all health expenses qualify. Assuming that you are under the age of 65 and use funds from the HSA on nonmedical expenses, a 20% penalty will be assessed on top of income taxes on the money. Remember: withdrawals are tax-free as long as savings goes toward paying for qualifying services. Accountholders aged 65 and older are not penalized like their younger counterparts. But the money that is withdrawn is still taxed.
The IRS notes that “qualifying” expenses are those that generally would be eligible for a medical or dental deduction. So, as you might imagine, the list of HSA-eligible expenses is long. They are generally categorized as:
Medical procedures and equipment
Over-the-counter drugs
Prescription medications
Dental, hearing and vision aids, products and treatments
Support for disabled accountholders
Premiums
Copays
As technology evolves and other changes arise, new services or products are added to the list of HSA-eligible expenses, for instance, as part of the CARES Act, telehealth and other remote care services, as well as formerly ineligible OTC drugs and supplies. These products include cough and flu products, sun protection, feminine hygiene and acne treatment. Notable ineligible items include cosmetic treatments (which differ from “medically-necessary” reconstructive procedures), care for a healthy child, marijuana (yes, even medical marijuana), missed doctor’s appointment fees, maternity clothes and infant formula in all instances, even when a woman can’t breastfeed.
In summary
So, you’re relatively healthy and are looking ahead to save for future health care expenses. Good for you! HSAs can be a great tool to reach those practical goals. Likewise, you are nearing retirement and could always use a little help paying for costs after you retire. You, too, may find HSAs to be an attractive option without the penalty that your younger counterparts are subject to. However, if you are staring down complex or costly medical treatment over the next year or so and are concerned about your ability to meet a high deductible, HSAs may not be as beneficial. Of course, no individual’s situation can be boiled down to a simple formula. Our tax team welcomes your questions, and intimately appreciates how health care programs play into your retirement planning. Don’t let unexpected expenses take the shine off of your golden years.
For more than 70 years, O’Donnell, Ficenec, Wills & Ferdig has had the privilege of supporting individuals and their families personal and business goals. Contact us to schedule your appointment with one of our experienced team members.