Using an HSA: Tax Deduction Now, Tax-Free Money Later for Medical Expenses
by Micah Shilanski, CFP |
HSAs (Health Savings Accounts) are special accounts designed to give you a tax deduction for qualified medical expenses.
If you qualify for an HSA, you decide how much money you want to contribute (up to a the limit) – and you decide when you use the money. If done correctly, you get a tax deduction for the money you put in now – and if you take the money out for qualified medical expenses, the money comes out tax-free.
Many people who use HSAs take money out now for their current medical expenses. And this can still be beneficial to your taxes. But why not go the extra mile?
It’s pretty safe to say that at some point in retirement – you’ll have to pay for medical expenses out of pocket. Why not save for it and get the tax advantage?
So if you’re in good financial shape, consider funding your HSA each year you can to get the tax deduction.
Then in the years leading up to retirement, when you do have medical expenses, pay for those out of pocket and leave your HSA to grow. When you take it out for qualified medical expenses your contributions and interest come out tax-free.
Who Can Have an HSA?
There are special rules for HSAs, and they’re not ideal for everyone. In order to qualify for an HSA, you must…
- Have a High-Deductible Health Plan (HDHP)
- You can’t be covered by any other insurance plan that’s not HDHP
- You can’t be claimed as a dependent on anyone else’s tax return
- You can’t be on Medicare.
The IRS has a special publication about HSAs, Pub 969 Health Savings Accounts and Other Tax-Favored Health Plans.
How Much Can You Contribute to an HSA?
In 2012, the amount of money you can put into an HSA is $3,100 for an individual, or $6,250 for a family. And you can put in an additional catch-up provision of $1,000 if you’re over age 55. If both you and your spouse are over age 55, that means your family limit could be as high as $8,250 a year.
Limited Window to Fund HSA
One of the qualifications to fund an HSA is that you are not on Medicare. Since most federal retirees will start Medicare at age 65 - this means the ‘window’ to fund your HSA is limited.
For example, say you’re 55 now and you’ll be going on Medicare at 65. If you qualify for an HSA (and continue to qualify each year) – that only leaves you with 10 years to fund your HSA. But if you’re 62 now, you might only have 3 years to be funding your HSA.
You can still use the money in your HSA account after you go on Medicare – but you’ll no longer be able to put more money into your HSA and receive a tax deduction. So the window to fund your HSA is limited.
HSAs are Not For Everyone
HSAs are not right for everyone. Let’s take a closer look at some things to think about if you’re considering an HSA…
#1) Must Be a Good Fit for HDHP
In order to have an HSA, you must have a High-Deductible Health Plan. So before you consider an HSA, you need to make sure that having a HDHP is good for you. If you’re not comfortable with an HDHP, then an HSA is not right for you.
If you’re in good health, and you rarely hit your deductible, you might be a good candidate for a high-deductible plan. In general, the higher your deductible, the lower your premium costs – so moving to a high-deductible plan might save you money. But only if you are in good health and don’t have a lot of medical expenses.
If you hit your deductible every year, or have a lot of medical expenses – it probably doesn’t make sense to do a high-deductible plan.
OPM has a page of helpful links about the HDHP plans and how they work with HSAs.
#2) Must Be Comfortable with Responsibility of HSA
There is not a lot of oversight with an HSA when you compare it to other plans like FSAs. You can take money out of your HSA to pay for qualified medical expenses - but you are the one responsible for making sure the expenses you have are qualified or not.
No one will stop you from taking money out of your HSA for something that’s not qualified – but you’ll be hit with taxes and penalty when it’s found by the IRS.
#3) Must Understand Additional Tax Requirements
With an HSA, you are responsible for reporting some additional information on your tax return each year. For example, you’ll need to report how much money you contributed, how much money you took out (if any), and how much of that was for qualified medical expenses.
You must also keep good records showing your medical expenses were qualified. While you don’t submit these with your taxes – you are to keep them with your own personal tax records in case the IRS has questions in the future.
Extra Consideration for the Long-Term Play: Must Be in Good Financial Shape
Using an HSA to pay for medical expenses in retirement means that you need to have the cash to fund your HSA now, and the ability to wait for years (possibly even decades) to use it.
So in order to make this work – you need to be in good shape financially to be able to save the money and still pay for your expenses out of cash-flow now.
This idea gets the most bang for your buck when you can let that money ride and be a bit of a safety net 20 years from now.
HSA: Tax Deduction Now, Tax-Free Money Later for Medical Expenses
When you use this right – you get a tax deduction now, and get to use the money tax-free for qualified medical expenses (that you were probably already going to have to pay for anyways).
But this way, instead of having to pay for those medical expenses on dollars that were taxed – you can get a tax benefit.
This is a more advanced planning technique best suited for people who are doing well and who already have their financial ducks in a row.
Using an HSA to save for medical expenses in retirement is a long term play. But if you’re in good health and in good financial shape – you might be able to take advantage of the benefits of using an HSA this way.
Interested in Learning More?
I’ve taken my experience as a pre-retirement class teacher and as a financial planner for federal employees and created an online do-it-yourself program called FERS Route to Retirement. HSAs are just one of the topics covered in my online program called FERS Route to Retirement.
© 2013 Plan-Your-Federal-Retirement.com. Plan Your Federal Retirement is a dba of Shilanski & Associates, Inc., an Alaska Registered Investment Advisor, with securities offered through Summit Brokerage Services, Inc., Member FINRA/SIPC.
by Micah Shilanski, CFP |