Health savings account provides triple tax benefit

June 1, 2016

One of the greatest benefits of being covered under a high-deductible health plan is generally the ability to open a health savings account and receive tax-preferred treatment on money saved for medical expenses.

 

What are the benefits of a health savings account?

One of the greatest benefits of being covered under a high-deductible health plan (HDHP) is generally the ability to open a health savings account (HSA) and receive tax-preferred treatment on money saved for medical expenses. Specifically, HSAs provide a triple tax benefit: tax-deductible contributions, tax-free earnings, and tax-free withdrawals. Being aware of the tax-saving opportunities of an HSA will give you a better understanding of how to take full advantage.

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An HSA is used to save money to cover out-of-pocket medical expenses not covered by your health insurance plan. Many banks and brokerage firms offer HSA plans with various interest- and dividend-earning options.

One benefit of having an HSA is that your contributions are tax deductible. Although there are annual limits to the amount that can be contributed, your HSA contributions can be claimed as a deduction on your tax return even if you do not itemize your deductions.

Also see: Can life insurance be used to pay estate taxes?

For 2016, if you have individual health coverage, the maximum tax-deductible contribution remains the same as last year at $3,350, and for family coverage the contribution limit increased to $6,750. For those 55 and older, the additional contribution limit remains at $1,000.

Next: "Many employers offset a portion of your health care costs by making contributions to your HSA."

 

Many employers offset a portion of your health care costs by making contributions to your HSA. Although you may not deduct any contributions made by your employer, those amounts are generally excluded from your gross income, meaning they are tax free. In addition, the contribution limits remain the same whether the contributions are made by you or your employer.

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For example, if you had individual coverage the entire year and are under the age of 55, your contribution limit is $3,350. If your employer contributed $1,000 to your HSA, the amount you may contribute, and deduct, is limited to $2,350.

Contributions to your HSA can be made throughout the year or in one lump sum. To encourage you to maximize your HSA contribution benefit, if the annual contribution limit is not reached by year-end, you may continue to make contributions to your HSA through the tax return filing deadline the following year (without extensions) until the limit is reached.

A second tax advantage of owning an HSA is that withdrawals for eligible medical expenses are tax free. Eligible medical expenses are those that would generally qualify as an itemized medical expense deduction.

A third great tax benefit of HSAs is that any interest or dividends earned on them are tax free. Since HSAs do not have a mandatory distribution requirement, the contributions made to your HSA can stay there and continue to grow tax free until you need to make a withdrawal.

If you make a withdrawal for non-eligible medical expenses before age 65, you will have to pay tax on the amount withdrawn plus a 20% penalty. If you are 65 or older, there is no penalty, but you will still have to pay tax.

Finally, another benefit of owning an HSA is that you may keep your HSA open and continue to enjoy tax-free growth and tax-free withdrawals even if you are no longer eligible to make tax-deductible contributions. This means that when you are no longer enrolled in an HDHP, or if you change employers or leave the work force, your HSA can remain open.

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With a better understanding of how HSAs work and their benefits, it is easier to appreciate their value. As the owner of an HSA, you will get not only the triple tax benefit of tax-deductible contributions, tax-free earnings, and tax-free withdrawals, but also the opportunity to build a healthy medical nest egg to cover current and future health care expenses.

Next: Can you use money in an IRA to purchase a home without incurring a tax penalty?

 

Can you use money in an individual retirement account to purchase a home without incurring a tax penalty?

Yes, but only if it’s a withdrawal for a first-time home purchase. This exception allows penalty-free IRA withdrawals to the extent the money is spent by the IRA owner within 120 days to pay for qualified acquisition costs for a principal residence. However, there's a lifetime $10,000 limit on this exception. The principal residence can be acquired by:

  • the IRA owner or the IRA owner's spouse

  • the IRA owner's child, grandchild, or grandparent, or

  • the spouse's child, grandchild, or grandparent.

The buyer of the principal residence (and the spouse if the buyer is married) must not have owned a present interest in a principal residence within the 2-year period that ends on the acquisition date.

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Send your questions about estate planning, retirement, and investing to Joel M. Blau, CFP, c/o Urology Times, at UT@advanstar.com. Questions of general interest will be chosen for publication. The information in this column is designed to be authoritative. The publisher is not engaged in rendering legal, investment, or tax advice.

 

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