HSA’s, FSA’s, HRA’s…“Whoop-de-doo! What does it all mean, Basil?”
When you hear the words “We would like to have you as a member of our team.”, it is beyond exciting, you landed the job. However, reality sets in when Human Resources provides you with a benefits package. You are inundated with information and jargon you may have never heard of. To make this process less daunting, for this month’s blog we decided to focus on a potential piece of the package: medical coverage and specifically the savings accounts that may be offered relating to that medical package.
There are multiple health savings accounts that are available, such as Health Savings Accounts (HSA), Flexible Savings Accounts (FSA), and Health Reimbursement Arrangements (HRA). The next logical question and to quote Austin Powers: “Whoop-de-doo! What does it all mean, Basil?”. All of these accounts have different characteristics and rules, thus to save time we are going to highlight one account that was recently created and is growing in popularity - the HSA. To explain the HSA, we have broken the account into the following sections: History & General Characteristics, Eligibility, Contribution Rules, Distribution Rules, and Advantages.
History & General Characteristics
The HSA was created through the Medical Prescription Drug and Modernization Act of 2003. Its purpose is to provide a tax-free vehicle for individuals with high-deductible health insurance policies, allowing them to supplement and cover the large out-of-pocket expenses they may incur. If you took a Roth IRA and a Traditional IRA and smashed them together, the result? An HSA account. For example, you make tax-deductible contributions (like a Traditional IRA), the monies grow tax-free (just like a Traditional and Roth IRA), qualified distributions are tax-free (just like a Roth IRA), there are no required minimum distributions (same as a Roth IRA), and opening an account is not employer-dependent (just like a Traditional and Roth IRA). The government created an IRA account on steroids, thus its characteristics are enticing, but who is eligible?
To be eligible to open an HSA you need to meet the following criteria:
You must be covered under a high-deductible health plan (HDHP), on the first day of the month
You have no other health coverage except what is permitted under “Other health coverage”
You are not enrolled in Medicare
You cannot be claimed as a dependent on someone else’s tax return
All of those are clear cut, except for the criteria for the HDHP. Don’t fear, Table 1 below gives the criteria for what is considered to be a HDHP for 2016.
To further clarify, your health plan must exceed the “Minimum annual deductible” and fall short of the “Maximum annual deductible” shown. For example, if you carry family coverage and your annual deductible is $3,000 and your annual deductible and other out-of-pocket expenses are less than $13,100, your plan would be considered a HDHP and you would be eligible to establish an HSA.
So, if you can check off all of the bullet points above, then you are eligible to establish and contribute to an HSA, but how much can you actually contribute?
As mentioned in the “History & General Characteristic” section, contributions that are made to an HSA are tax-deductible. The deductions are considered an above the line deduction, meaning even if you do not itemize your deductions you can still benefit from contributing to an HSA. Unlike a traditional IRA, HSA contributions are not dictated by income. So, if a high-income earner meets the eligibility requirements, all contributions will be tax-deductible. However, just like any other IRA, if you over contribute, you are subject to a penalty. The only pitfall to HSA contribution rules is you are not allowed to contribute after age 65, which makes sense since at age 65 you would most likely be covered by Medicare, meaning you would not be eligible for an HSA anyhow.
Lastly, Table 2 provides the contribution limits for 2016 (limits include both employee and employer contributions). Please note: at age 55 you are allowed to contribute an extra $1,000 to your HSA, also known as a catch up contribution.
Taking distributions from an HSA is great. Why? Because if the distribution is qualified you do not need to pay taxes. So, what is a qualified distribution? According to the IRS, qualified medical expenses are “those expenses that would generally qualify for the medical and dental expenses deduction.”. To put it simply, it is a long list. So, if you do have questions about a certain expense, please contact us and we can help get an answer. A distribution being qualified or not is important because if the funds are not deemed a qualified distribution, the amount will be considered income and you will receive an additional 20% tax penalty.
Another benefit to HSA distributions is if you do not dip into your account, the money will carry over to the next year and the next and so on, unlike an FSA, and there is no required minimum distribution. This allows you to grow your health account tax-deferred, leading me into the next benefit: the ability to roll your HSA into an IRA account. For example, let’s say you started to contribute to an HSA at the age of 30. You used the account throughout the years to cover qualified expenses, but did not spend all of it. By age 65, you apply for Medicare and are now ineligible to contribute to an HSA, you can then roll that account into an IRA and use it for retirement income or continue to it use for qualified medical expenses. The ability to keep unused funds and roll-over the account to an IRA makes the HSA a versatile vehicle.
An account that can be established, if eligible, to help cover qualified medical expenses
Not employer dependent
Contributions are tax-deductible, regardless of income
Funds grow tax-deferred
Qualified distributions are taken out tax-free
Unused funds throughout the year carry over year to year and there are no required minimum distributions
The ability to roll-over to an IRA at any point
As you can see the advantages of an HSA are plentiful. However, this type of an account is only part of an overall financial plan. Each individual should examine their current situation to determine the appropriate contribution amount and its purpose inside their plan.
 Austin Powers: The Spy Who Shagged Me. Dir. Jay Roach. Eric’s Boy, Moving Pictures, Team Todd, 1999. Film.