If you had a qualifying high deductible health insurance plan in 2020, you still have time to open AND fund a Health Savings Account (“HSA”) before the May 17th deadline. Thanks to recent Covid relief legislation, taxpayers have one last chance to still get a tax write-off for 2020 before the extended deadline, and fund one of the best tax strategies for health care savings and wealth building.
The HSA is truly one of the most underutilized tax strategies by every tax-paying American and especially small business owners who have more latitude in choosing the right type of health insurance that opens the door to this incredible opportunity.
The 5 Main Reasons You want an HSA
Created by Congress in 2001, they are perfect for the individual or family who is ‘generally healthy’ and can afford or risk coming out of pocket for the little things and rely on a ‘high deductible’ insurance policy. Here’s a sampling of some of the benefits of HSAs:
- You save on taxes in ANY tax bracket. There are no phase-out limits for high-income earners, no requirement for a certain type of income, or for those with simply passive income. Anyone with the right type of insurance policy (more below) can deduct contributions into their HSA directly from their gross pay amount on the front page of their tax return!
- You can also spend the money in the HSA tax-free ANYTIME. There is no waiting period after a contribution, minimum age you must be, or time limit on a medical reimbursement from the account. The only catch is that withdrawals or disbursements must be spent on qualifying health care expenses. But no worries there either! The list of qualifying medical expenses is a long one and can easily be identified in IRS Publication 502. This tax-free rule on spending applies for the rest of your life!!
- An HSA grows tax-free and can be invested in anything you want. Don’t be tricked into thinking your only able to earn a measly 2-3% (if you’re lucky) in a mutual fund at a bank-sponsored HSA. You can self-direct the investments in an HSA and purchase individual stocks, real estate, cryptocurrency, silver, gold, small business ownership, or whatever you know best in making money. Learn more on how to self-direct and set up your Self-Directed HSA at www.directediRA.com.
- You can save money on insurance premiums and health care costs. The HSA qualifying health insurance policy by its very nature often has a lower premium and saves you on hard-earned wages or business profits. Moreover, the ability to pay cash for health care costs often allows you to negotiate for lower-cost services and motivates all of us to be more healthy by not blindly paying for unnecessary medical procedures or benefits typically covered by insurance.
- If you don’t use the HSA for medical expenses, it can help pay with retirement. After you turn 59 1/2, there is also the option to withdraw the money from an HSA for non-healthcare expenses. Yes…you would have to then pay federal income taxes on it on the withdrawal, but no penalty. The HSA then acts much like a traditional IRA with the added perk that you don’t have the mandatory disbursements usually required by traditional IRAs (referred to as RMDs).
For 2020, a single taxpayer with a High Deductible Health Care Plan (“HDHP”), can contribute up to $3,550. A married couple, or one filing as head-of-household with a family HDHP, can contribute up to $7,100. The deadline for a 2020 contribution AND deduction is May 17, 2021.
Essentially, the HSA is much like an IRA and operates as tax-favored savings account for health care. Except it’s better! You get a tax deduction when it goes in, it grows tax-free, and it comes out tax-free at ANY time, at ANY age, for a qualifying medical expense, which includes a long list of items…the HSA is simply amazing!!
The Health Insurance Requirement
The only requirement to qualify for one of these amazing accounts is that you have to use a qualifying high-deductible health insurance plan (HDHP). Once you have the proper insurance, you can create an HSA account almost anywhere (not where your employer dictates) AND EVEN self-direct it into alternative investments. I actually own a rental property in my family’s HSA- seriously!
The rule for a 2020 deduction is that you must have had the HDHP in place before the Enrollment Period was over on December 15, 2020. Essentially, this type of plan hinges on a ‘high deductible’. In 2020, a qualifying minimum high-deductible was $1,400 for a single individual and $2,800 for a married or head of household taxpayer. Nonetheless, these plans are specifically designed to qualify for the HSA and is a whole other topic beyond the scope of this article. Visit www.healthcare.gov for more information on what type of plan is considered an HDHP.
Am I too old to have an HSA?
Yes and no. The HSA has a couple of interesting rules once a taxpayer turns 55.
First, when you are between the ages of 55 and 65, you can contribute an extra $1,000 to your HSA each year. What this means is that if your single, that’s a contribution of $4,550 in 2020 or $4,600 in 2021. If you’re married or filing as head of household with a family HDHP, you would be able to make a contribution of $8,100 in 2020 and $8,200 in 2021.
However, a major drawback of the HSA, is that once you turn age 65, you are no longer able to make contributions. But in turn, you are allowed to continue investing your HSA and take out funds for qualifying medical expenses at any age.
Obviously, the rules above regarding HSAs and those in their ‘golden years’ can create some unique questions and counter-strategies. Here are a few Frequently Asked Questions that might shed some light on these interesting situations:
FAQ #1- Is the contribution restriction imposed before the year I turn age 65, or before my birthday? You are allowed the deduction before you turn 65, not before the year you turn age 65. So if your 65th birthday is June 23rd, 2022, make sure you make your HSA deposit for 2022 before your actual birthdate, maybe June 20, 2022, perhaps.
FAQ #2- If my spouse and I are both between the ages of 55 and 65, can we put $2,000 in our family HSA with the make-up provision? No. This is when it would be most strategic to set up two individual plans. It may seem a little cumbersome and create some extra procedures and paperwork, but under two indivdiual plans, you could each make an additional $1,000 contribution effectively allowing you to put away, and take a tax deduction, in 2021 for $9,200, rather than $8,200. Note: You would keep the family HSA in place, continue to invest it, and make withdrawals, but no longer ‘contribute’ to the family HSA that you had in place before setting up the two single plans.
FAQ #3- What if my spouse is over age 55, but I am not, should we set up two individual plans? No. As long as one of the spouses is between age 55 and 65, you can keep the family plan, and make the additional $1,000 contribution into the family plan for both of you. For example, one spouse is 57 and the other 51, the married or family HSA contribution/deduction for 2021 would be $8,200. Note: It would be extra work and no additional financial benefit to set up two individual plans in this situation.
FAQ #4- What if my spouse turns 65, but I am between the ages of 55 and 65, can I/we continue to contribute to the family/married HSA Plan? No. At the point one of the spouses turns age 65, you can no longer make contributions to the married HSA. The spouse under age 65 would need to set up an individual plan, and in 2021 would be able to make a contribution and take a deduction on the joint tax return of $4,600. The spouse over age 65 would no longer be able to contribute to the plan. However, the married HSA plan would live on, could still be invested (just no new contributions made to it), and the spouse over age 65 could enjoy distributions from the married HSA for qualifying medical expenses until the day they die. The spouse under age 65 would begin building an individual HSA until he or she turned age 65 and could no longer make contributions.
FAQ #5- What happens to my HSA when I die? Upon your death, your HSA will be directly transferred to your spouse and becomes their HSA. If your beneficiary is not your spouse, your HSA ends on the date of your death and the remaining funds are distributed to the beneficiary listed on the account. They can only roll into a surviving spouse’s HSA. However, the HSA can continue to pay funds tax-free for medical expenses incurred by the former account holder for up to 1 year after their date of death.
What if I’m so unhealthy the HSA doesn’t work for me?
If you are unhealthy and don’t have the qualifying type of insurance, you still have an option. IF you own a small business, you can get a tax deduction for your out-of-pocket deductible, co-pays, medical expenses, prescription drugs, dental, and even eye care, by utilizing a Health Reimbursement Arrangement. For more information on this strategy see my article: “How the HRA can Save You Thousands in Taxes when facing Health Care Costs.”
However, if you are generally healthy and have a ‘choice’ as to what medical plan you were stuck with in 2020, or have a choice in 2021, PLEASE take a second look at the HSA. It could be one of the biggest tax-saving strategies AND health care-saving strategies of your life. Don’t underestimate the power of the HSA.
Remember, some important key points:
- You don’t have to be a business owner to have an HSA
- The deadline to set up AND fund an HSA for a 2020 contribution and deduction is May 17th, 2021
- if you didn’t set up the plan in 2020…it’s ok! You can still set up the HSA before May 17th
- The critical factor is that you had an HDHP in 2020
- You could have a personal HDHP or have the proper health insurance (HDHP) through your employer
- If you are between the ages of 55-65 you can do a make-up contribution of $1,000 in your single or married plan
- If you are over age 65 you can’t make new contributions, but you can keep investing it and pulling out money tax-free for qualifying medical expenses
- Also, if you’re over age 65 you can use the HSA funds for non-medical expenses, but any funds used for non-qualified medical expenses would be treated as ordinary income taxes (just like an IRA).
Bottom line, as a small business tax lawyer and advisor, our team consistently and strongly encourages clients to understand the power of an HSA and utilize them whenever possible in their overall business, wealth building, and tax planning structure. It really does surprise taxpayers when they find out what they have been missing out on in regards to HSA benefits!
Mark J. Kohler is a CPA, Attorney, co-host of the PodCasts “The Main Street Business Podcast” and “The Directed IRA Podcast”, and the author of “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You” and, “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”, as well as several other well-known books. He is also the CFO of Directed IRA Trust Company, and a senior partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP, and the accounting firm K&E CPAs, LLP.