Healthcare Savings Account Contribution Amounts Increased for 2022 and 2023

Americans are generally aware of tax-advantaged investment vehicles such as 401(k) plans, individual retirement accounts and 529 college savings plans. The health savings account, or HSA, isn’t as well known, although it offers three separate tax benefits.

HSAs combine the best of the Traditional IRA and the Roth IRA.  Contributions are tax-deductible in the year they are made (like a Traditional IRA) and both the ongoing earnings and any withdrawals used for qualified medical expense are tax-free.  There’s no other vehicle under the tax code that offers this kind of preferential treatment.

Qualified medical expenses include most services provided by licensed health providers, as well as diagnostic devices and prescriptions.  HSA funds can also be used to pay for long-term care insurance premiums, COBRA coverage, health care coverage while unemployed, and once you are age 65 or older, Medicare or other health care insurance premiums.

Unlike health care flexible spending accounts (“FSAs”), which have a maximum year-to-year carry-over of $500, HSAs have no limit on carry-overs.  Even if the account is opened through an employer-sponsored program, all money in an HSA belongs to the account owner.  Accounts are held with a trustee or custodian, which may be a bank, credit union, insurance company or a brokerage and can be invested in bank accounts, annuities, stocks, mutual funds or bonds.

The catch to taking advantage of an HSA is that you (and/or your family) need to be enrolled in a “high-deductible health insurance plan” in order to make a contribution.  The limits for 2022 and 2023 are as follows:

To be eligible to contribute to an HSA, you can’t have any other health insurance coverage (other than an HDHP), you can’t be enrolled in Medicare and you can’t be claimed on someone else’s tax return.

Since the onset of the Affordable Care Act and over the past several years, many plans now qualify as a high-deductible health care plan (“HDHP”).

We typically advise clients to take advantage of enrolling in HSA-eligible, high-deductible health plans if their employer offers them and they don’t typically, or currently, have high out-of-pocket health care expenses.  When it makes sense, we recommend contributing the maximum amount to the HSA annually, as this allows you to save tax-free for future health care costs.

For some folks closer to retirement, funding your HSA even at the expense of lowering retirement plan contributions may make some sense.  We all know that medical expenses will come into play at some point later in life and planning for this makes sense.  And statistics are easily obtainable indicating that the average lifetime, out-of-pocket expenses for health care in retirement approach $250,000.  So why not take advantage of the deduction for current contributions and the tax-free nature of the distributions if you can afford to?  Contributing to your HSA is still saving for retirement, but the funds are earmarked specifically toward future medical expenses.

Starting at age 65, account owners may make tax-free withdrawals for qualified medical expenses.  There is no time limit on when you need to use up your funds and your spouse can be named beneficiary and, upon your death, use the HSA for the same purposes.

Investing your HSA account for long-term appreciation and letting it grow tax-free, rather than spending it on current health care needs, can also help maximize the benefit to help cover health care costs later on in life.  In this sense, the HSA resembles a Roth IRA in that it grows tax-free, but you also get the benefit of a current income tax deduction.  From a retirement and financial planning perspective, we advise clients to keep growing the HSA as long as possible as a hedge against the risk of rising health care costs.

OK that all sounds great, so what else do I need to know?

• Before age 65, account owners face a 20 percent penalty for withdrawals for nonqualified medical expenses. These include elective cosmetic surgery, hair transplants, teeth whitening and health club memberships, among other things.
• After age 65, withdrawals other than for qualified medical expenses are taxed as ordinary income (like a withdraw from a pre-tax IRA or 401(k)).
• When the beneficiary is not your spouse, the HSA ends on the date of your death and your heirs receive any balance as a taxable distribution.
• Once you are enrolled in Medicare, your employer (on your behalf) cannot make HSA contributions.

The bottom line is that an HSA is really an important financial planning tool and, if you are eligible, you may benefit from taking some time to consider one for yourself.  Like saving for retirement, the sooner you can start HSA contributions and allow them the time to grow, the more likely they are to have a material impact on your planning.

To quickly fund an HSA, you can make a tax-free rollover from an IRA to an HSA once in your lifetime, which is known as a qualified HSA funding distribution (QHFD).  The rollover is limited to the maximum allowable contribution for the year, minus any amount already contributed.  To be eligible to make a QHFD, you must be enrolled in a HDHP and remain eligible for an HSA for at least 12 months after the transfer.

Please reach out to your Wealth Advisor if you have questions or for additional information.

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