Health Savings Accounts – Bigger & Better

Health care costs have continued to skyrocket.  There seems to be little that small business owners and others paying for their own health insurance can do other than gritting our teeth and tightening our belts. 

Health Savings Accounts (HSA’s) are one of the few ways that we can fight back against rising health care costs.  A Health Savings Account is a custodial account set up with a qualified HSA trustee to pay or reimburse you for medical expenses you incur.  You must be an eligible individual (see below) to qualify for an HSA. A qualified HSA trustee can be a bank, an insurance company or anyone approved by the IRS to be a trustee of an IRA. 

The benefits of a Health Savings Account are significant.

  • Tax deductible contributions. Contributions to Health Savings Accounts are tax deductible for Federal tax purposes.  For 2021, the maximum contribution to an HSA is $3,600 for individuals with self-only coverage and $7,200 for individuals with family coverage.  Individuals over age 50 can make an additional $1,000 yearly contribution.
  • Tax-free growth. Contributions remain in your account until you use them.  The money can be invested in anything from a checking account to a mutual fund. The investment growth or earnings in the account is tax-free.
  • Tax-free distributions. Distributions from your Health Savings Account will also be tax-free if you pay qualified medical expenses.  See below for more discussion on this, because the definition of qualified medical expenses has been expanded for 2020 and beyond.
  • Portability. Your Health Savings Account is portable.  That is, it stays with you if you change employers, become self-employed, retire or otherwise leave the workplace.

Only eligible individuals can set up Health Savings Accounts. An “eligible individual” must meet the following requirements:

  1. You are covered under a high deductible health plan (described below), on the first day of the month. For 2021, a high deductible health plan must have a minimum deductible of $1,400 ($2,800 for family coverage) and a maximum deductible of $7,000 ($14,000 for family coverage).  These numbers represent the minimum and maximum out of pocket costs that the covered individual is liable for.
  2. With some exceptions, you generally cannot have any other health coverage.
  3. You aren’t enrolled in Medicare.
  4. You can’t be claimed as a dependent on someone else’s tax return.

The beauty of the Health Savings Account is that it can convert previously non-deductible expenses into tax deductions. For example, let’s say you have an HSA and you just received a dental bill for a crown that costs $2,000.  For most taxpayers, this would be a non-deductible medical expense, paid with after-tax dollars. However, if the cost of the crown is paid out of your HSA and your Federal tax rate is 32%, your cost after the tax deduction is only $1,360, a savings of $640!  Why? Because your contribution to the HSA was tax deductible, so paying the dental expense with pre-tax dollars saved you $640 in income taxes.  In a sense, you received a discount on your crown just for being tax wise.

There’s more good news for owners of Health Savings Accounts.  The definition of “qualified medical expenses” has been expanded.  In the past, qualified medical expenses included the usual items such as co-payments for medical services, prescriptions, dental and vision costs, contact lenses, eyeglasses, medical-related chiropractic expenses, weight loss programs, bandages and medical supplies.  Now, under the Coronavirus Aid, Relief & Economic Security (CARES) ACT, qualified medical expenses reimbursed by an HSA also include the following:

  • Over-the-counter medications including but not limited to aspirin, other pain medications, cold and flu products or allergy relief are now qualified expenses paid by an HSA.
  • Menstrual care products such as tampons and pads are also reimbursable by your Health Savings Account.

Health Savings Accounts cannot be used to pay for health insurance premiums unless the covered individual is receiving unemployment compensation or paying for COBRA premiums. HSA’s can be used to pay for qualified long-term care insurance or for Medicare Part A or B premiums after turning age 65.

As always, check with your tax advisor or call us to see if setting up a Health Savings Account is right for you.

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