By Steven C. Merrell
When it comes to saving for the future, Health Savings Accounts are one of the best things going right now. Not only do they deliver an unparalleled tax benefit for participants, but changes brought by the CARES Act have made them a lot more flexible. However, like most government programs, there are plenty of rules to keep straight.
HSAs provide a unique triple tax benefit. First, contributions are tax-deductible in the year they are made. Second, assets grow tax-free while they are in the HSA. Third, withdrawals are also tax-free as long as they are used to pay for qualified medical expenses. But be careful. If you use your HSA funds for non-qualified expenses, the IRS can impose a hefty 20 percent withdrawal penalty.
What counts as a qualified medical expense has broadened thanks to the CARES Act. For example, over-the-counter drugs such as cough suppressants, pain relievers, antihistamines and a host of other drugs and medical products, including feminine hygiene products, purchased after Jan. 1, 2020 are now HSA-eligible. These changes are permanent.
To be eligible to make tax-deductible HSA contributions, you must meet a few basic requirements.
You must not be on Medicare.
You must be covered by a high-deductible health plan. In 2020, the deductible must be at least $1,400 with an out-of-pocket maximum of $6,900 for individuals. For families, the deductible must be at least $2,800 with an out-of-pocket maximum of $13,800.
You must not be covered by any other medical plan.
You must not be claimed as a dependent on someone else’s 2019 tax return.
Eligible individuals who are covered by a self-only high-deductible health plan can contribute up to $3,550 for the 2020 tax year. The family contribution limit is $7,100. In addition, account holders who reach the age of 55 can make a $1,000 “catch-up” contribution whether they are contributing as an individual or a family. There is no income limit for HSA contributions.
A lot of people use their HSAs to pay for current medical expenses. However, if you want to enjoy the full benefit of your HSA, it is best to let your HSA grow for the long term.
HSA rules can get a little tricky as people become eligible for Medicare. Here are some things you need to know.
In the year you qualify for Medicare, your HSA contribution limit is prorated for the proportion of the year before you start on Medicare. For example, if you start Medicare in October, your HSA contribution limit will be prorated for the three-quarters of the year you were HSA eligible. Therefore, your contribution limit as an individual would be $2,662.50 ($3,550 x 0.75). You would also be able to make three-quarters of the $1,000 catch-up contribution or $750.
It gets a little more complicated if you become Medicare eligible and your spouse is still on a high-deductible health plan. In that case, you get the prorated family contribution limit for the time you are both HSA-eligible and your spouse gets the prorated individual contribution limit for the balance of the year. Using the previous example, you would get three-quarters of the full family contribution limit of $5,325 (0.75 x $7,100) plus three-quarters of the catch-up, or $750. For the balance of the year, your spouse would get one-fourth of the individual limit, or $887.50 plus the entire year’s catch-up contribution, since she was eligible for it for the entire year.
One final point about Medicare and HSAs: an HSA account holder can use her HSA dollars to pay premiums for Medicare parts B and D or Medicare Advantage plans if she is 65 years of age or older. If she is not yet 65 years old, she cannot use her HSA dollars to pay for her older spouse’s Medicare Advantage premium.
Steven C. Merrell is an investment adviser and partner at Monterey Private Wealth Inc., in Monterey. Send questions concerning investing, taxes, retirement or estate planning to Steve Merrell, 2340 Garden Road Suite 202, Monterey 93940 or firstname.lastname@example.org.