Given the ever-escalating cost health care, one cost-effective option to consider is a health savings account (HSA). For eligible individuals, HSAs offer a tax-favorable way to set aside funds to meet future medical needs. Here are the key tax-related elements:
- contributions you make to an HSA are deductible, within limits,
- contributions your employer makes aren’t taxed to you,
- earnings on the funds within the HSA are not taxed, and
- distributions from the HSA to cover qualified medical expenses are not taxed.
Who is eligible? To be eligible for an HSA, you must be covered by a “high deductible health plan”. You must also not be covered by a plan which (1) is not a high deductible health plan, and (2) provides coverage for any benefit covered by your high deductible plan.
For 2017, a “high deductible health plan” is a plan with an annual deductible of at least $1,300 for self-only coverage, or at least $2,600 for family coverage. Additionally, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits cannot exceed $6,550 for self-only coverage or $13,100 for family coverage.
An individual who has reached age 55 before the close of the tax year may make additional “catch-up” contributions for 2017 of up to $1,000.
Deduction limits. You can deduct contributions to an HSA for the year up to the total of your monthly limitations for the months you were eligible. For 2017, the monthly limitation on deductible contributions for a person with self-only coverage is 1/12 of $3,400. For an individual with family coverage, the monthly limitation on deductible contributions is 1/12 of $6,750. Thus, deductible contributions are not limited by the amount of the annual deductible under the high deductible health plan.
If an individual is enrolled in Medicare, he is no longer an eligible individual under the HSA rules, and so contributions to his HSA can no longer be made.
Employer contributions. If you are an eligible individual, and your employer contributes to your HSA, the employer’s contribution is treated as employer-provided coverage for medical expenses under an accident or health plan and is excludable from your gross income up to the deduction limitation, as described above. Further, the employer contributions are not subject to withholding from wages for income tax or subject to FICA or FUTA. The eligible individual cannot deduct employer contributions on his federal income tax return as HSA contributions or as medical expense deductions.
An employer that decides to make contributions on its employees’ behalf must make comparable contributions to the HSAs of all comparable participating employees for that calendar year. If the employer does not make comparable contributions, the employer is subject to a 35% tax on the aggregate amount contributed by the employer to HSAs for that period.
Employer contributions are also excludable if made at the election of the employee under a salary reduction arrangement that is part of a cafeteria plan. Although contributions to an employee’s HSA through a cafeteria plan are treated as employer contributions, the comparability rule does not apply to contributions made through a cafeteria plan.
Distributions. Distributions from the HSA to cover an eligible individual’s qualified medical expenses, or those of his spouse or dependents, are not taxed. Qualified medical expenses for these purposes generally mean those that would qualify for the medical expense itemized deduction. If funds are withdrawn from the HSA for other reasons, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it is made after reaching age 65, or in the event of death or disability.
Distributions from an HSA exclusively to pay for qualified medical expenses are excludable from the gross income of the account beneficiary even though the beneficiary is no longer an “eligible individual,” e.g., the individual is over age 65 and entitled to Medicare benefits, or no longer has a high deductible health plan.
As you can see, HSAs offer a very flexible option for providing health care coverage, but the rules are somewhat involved. Contact Us if you would like to discuss this topic further.