3 Health Savings Account (HSA) Fun Facts

February 5, 2016
3 Health Savings Account (HSA) Fun Facts

We recently told you that you have until tax day to maximize your 2015 HSA contribution. However, you may still be intimidated by the prospect of signing up for a health savings account. Here are three important facts about HSAs to get you started:

1. You may not have to pay federal taxes on contributions, growth and distributions of HSA funds

HSAs are one of the few savings vehicles that allow you to avoid federal income tax. The IRS usually likes to collect taxes on one end of a financial transaction. Think about traditional 401(k) accounts. Your contributions reduce your taxable income when you make payroll deductions and, when you retire, distributions are taxable income. With a Roth 401(k), your contributions are made with money that has been taxed and when you retire the distributions are tax-free. Uncle Sam gets a piece in either scenario.

With an HSA, you can make pre-tax payroll deduction contributions or, if you make an eligible contribution outside of your employer’s payroll, you can take an above-the-line deduction when you file your annual federal income tax return. Your HSA balance may accrue interest over time and many banks provide an option to invest HSA funds in stocks, bonds and CDs, which may yield a higher rate of return. Gains are generally not subject to capital gains tax or any other federal taxes, so your HSA balance may grow tax-free.

When you are ready to spend money from your HSA, the distributions will be free of any federal tax if used to pay for an IRS qualified medical, dental and vision expense. Out of pocket health expenses are considered to be qualified as long as they would generally qualify for a medical or dental expense deduction. Examples of eligible expenses may include deductibles, copayments and prescription costs.

2. HSAs can double as a retirement account

Many people do not realize that once you reach age 65, you can use money from your HSA for non-qualified health care expenses, like that trip to Paris you always dreamed of, without paying the additional 20 percent excise tax. But withdrawals for non-qualified expenses at any age will be treated as ordinary taxable income to you, just like a traditional 401(k) distribution. Before age 65, you’ll pay a 20 percent tax penalty on any non-eligible withdrawals, in addition to paying ordinary income tax on the withdrawal.

3. There is no time limit on reimbursing yourself from an HSA

Unlike a flexible spending account (FSA), which has a time limit to incur and file claims for reimbursement, an HSA rolls over year to year. Let’s say you open an HSA on January 1, 2014 and have Lasik surgery in February of the same year. Let’s also say that you did not realize that Lasik is an eligible expense from an HSA until years later in 2018. As long as you still have the receipt or other documentation that verifies the eligibility of the expense, including the date of service, patient name, provider name, a description of the service and cost, you may be able to reimburse yourself for that expense without paying any federal income tax. You must also keep records sufficient to show that:

  • The distributions were exclusively to pay or reimburse qualified medical expenses.
  • The qualified medical expenses had not been previously paid or reimbursed from another source.
  • The medical expenses had not been taken as an itemized deduction in any year.

Another strategy for making the most out of your HSA is to pay for your health care expenses out-of-pocket with money that has been taxed and not request reimbursement from your HSA during your working years. Maximize your pre-tax contributions each year, save up all those receipts during your working years while letting your HSA balance grow tax-free. Then when you retire, you can reimburse yourself for all of the expenses you incurred during your working years for a hefty federal tax-free chunk of money.

These are just a few advantages to having an HSA and you will want to know all the rules to ensure you’re not risking any tax penalties. You’ll also want to know more about IRS eligible health care expenses and the high-deductible health plans that are required in order for you to have an HSA. TriNet can provide a wealth of resources to handle all your employee benefits needs.

This communication is for informational purposes only; it is not legal, tax or accounting advice; and is not an offer to sell, buy or procure insurance.

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